The six clubs named by Human Rights Watch are all minor. But the dispute over their location showed how sport, in the context of the Israeli-Palestinian conflict, was widening political divisions rather than bridging them.
In a report, HRW said the Israeli teams, from the settlements of Maale Adumim, Ariel, Oranit and Givat Zeev, and a squad representing the occupied Jordan Valley region, were playing "on land unlawfully taken from the Palestinians".
Settlements are considered illegal under international law, although Israel disputes that.
In some cases, the grounds the Israeli teams are playing on are on land privately owned by Palestinians, HRW said.
"By holding games on stolen land, FIFA is tarnishing the beautiful game of football," said Sari Bashi, the director for HRW for Israeli and the Palestinian territories.
She said FIFA should require the IFA "to move all FIFA-sanctioned games and activities inside Israel".
The Israeli and Palestinian football associations, both FIFA members, hold diametrically opposed views on the issue.
"Politics should be kept out (of soccer), and we think FIFA should not allow itself to become embroiled in this matter," said Shlomi Barzel, spokesman for the Israel Football Association (IFA).
Jibril Rajoub, head of the Palestine Football Association, countered: "(Settlement) clubs must be stopped and Israel must be held to account. It is time to raise a red card to Israel, which does not respect international or FIFA laws."
Palestinians seek to establish a state in the West Bank and the Gaza Strip, with East Jerusalem as its capital. Israel captured those areas in a 1967 war and pulled out of the Gaza Strip, now run by Islamist Hamas movement, in 2005.
Earlier this month, 66 legislators from the 751-member European Parliament signed a letter to FIFA President Gianni Infantino calling on him to raise the settlement soccer issue at FIFA Council meetings to be held next month in Zurich.
The Palestinian Football Association has long complained that Israel hampers its activities, including limiting the movement of players between the West Bank and Gaza, and that it has barred some international travel. Israel has cited security concerns for its actions.
A FIFA-appointed committee led by South African Tokyo Sexwale and tasked with monitoring Israel's commitment to easing travel restrictions, was set up last year.
A FIFA spokesman has reported "marked progress" by Israel on the issue but the matter of clubs in settlements was still under discussion.
(Additional reporting by Ali Sawafta in Ramallah and Tim Hart in London; Editing by Jeffrey Heller and Richard Balmforth)
