The intergovernmental affairs minister says he'll be seeking re-election in a byelection now that he's cleared the air.
Penashue says an "inexperienced volunteer" in his organization — his official agent — was responsible for accepting the illegal donations.
The campaign manager, Reginald Bowers, was subsequently appointed by the federal government to the Canada-Newfoundland and Labrador Offshore Petroleum Board, which regulates the oil sector.
Bowers resigned from the board late Thursday afternoon, effective immediately, according to a board spokesman.
"Although I was unaware of the inaccuracies in the return, I believe I must be accountable to the people who elected me and therefore I am stepping down as the member of Parliament for Labrador and will seek re-election through a byelection," Penashue said in release.
"I will also be stepping down as minister of intergovernmental affairs and president of the Queen's Privy Council for Canada."
Penashue is the second member of Prime Minister Stephen Harper's cabinet to leave in the last month.
John Duncan resigned as aboriginal affairs minister after improperly lobbying a tax court judge on behalf of a constituent. Duncan, who was succeeded in his cabinet portfolio by Bernard Valcourt, remains an MP.
A curt news release from the Prime Minister's Office said Transport Minister Denis Lebel would take over Penashue's duties at intergovernmental affairs. Lebel has acknowledged he previously held a party membership with the separatist Bloc Quebecois in the 1990s.
"I would like to thank Mr. Penashue for his service as a minister and to the people of Labrador," Harper said in the release.
A PMO spokesman said "a byelection will be called in due course," while a Conservative party official confirmed Penashue will be the party's candidate, suggesting he need not seek the nomination.
The party also said the Receiver General has been reimbursed $30,000.
What was not clear Thursday was whether Penashue's byelection run is part of his compliance agreement with Elections Canada.
The elections watchdog is refusing to comment, but says Penashue is working with it to amend his 2011 campaign return.
Penashue won his seat by just 79 votes in an upset over Liberal incumbent Todd Russell in 2011. An Elections Canada review subsequently showed Penashue spent $4,000 over his limit of just under $84,500.
He also appeared to have accepted thousands of dollars in free flights across his expansive, remote riding — which would amount to a corporate donation.
Liberals are also demanding to know whether a $25,000 loan Penashue received from the Innu Development Limited Partnership came with a commercial rate of interest, as is required under the rules.
And Penashue has yet to explain how a St. John's construction company, Pennecon, showed up as a donor to his campaign account when the campaign issued tax receipts to six executives of the company.
Corporate donations are illegal under the Canada Elections Act.
Russell said Penashue should have stepped down months ago, but that he was nonetheless shocked to hear the news.
"In this part of the world, we use the word 'gobsmacked,'" Russell told The Canadian Press.
"Obviously there's an admittance here that something was absolutely and fundamentally wrong."
NDP Leader Tom Mulcair said Penashue should simply resign and let the investigators finish their work.
"I mean, he's still not admitting that he did anything wrong but he says he's done enough to have to resign but not enough wrong to stop him from running again, whereas the investigation is still ongoing," Mulcair said in an interview.
"There's no way to justify the type of stunt that he's pulling now."
Bowers said he resigned his appointment on the Canada-Newfoundland and Labrador Offshore Petroleum Board so as not to be a "distraction" during the coming byelection.
Bowers maintains he did nothing deliberately wrong as he managed Penashue's election finances.
"I'm going back to a job that I don't have to resign from — retirement," said Bowers, who turns 68 on Saturday.
He said Penashue's campaign was $2,000 below the spending cap, according to his calculations, when he was replaced as official agent last summer.
Bowers said he also believed that donations from six donors at the St. John's construction firm were legitimate.
"I do not agree with his resignation and I'm hoping people will realize how much he meant to them and will re-elect him," he said of the MP.
Penashue is not the only Conservative MP currently suffering under the glare of a campaign spending investigation.
Peterborough, Ont., MP Dean Del Mastro, the parliamentary secretary to the prime minister, is being investigated for his 2008 campaign return, with Elections Canada court documents suggesting he overspent his legal limit by $17,000 and then tried to cover it up.
The allegations have not been proven in court and no charges have been laid.
Penashue's decision to resign from both cabinet and his MP's seat in order to seek re-election in a byelection is not unprecedented.
Former Liberal cabinet minister Sheila Copps resigned briefly in 1996 to make good on her 1993 campaign promise to quit if the GST was not abolished. Copps was subsequently re-elected in her Hamilton riding.
Leo Abbass, mayor of Happy Valley-Goose Bay, the biggest town in Penashue's Labrador riding, said the MP has been a good, accessible local representative.
"Were there some mistakes made? Sure. Do those things happen? They do," said Abbass. "But I think if he's taking this step right now, I think that's a sign of his commitment to try to clear the air and then move on."
— With files from Joan Bryden in Ottawa and Sue Bailey in St. John's, N.L.Suggest a correction