Members agreed during a lengthy meeting on Tuesday to back amendments to religious discrimination legislation to shield people expressing their religious beliefs, even if they are offensive or insulting, from discrimination claims.
A controversial clause of the Sex Discrimination Act would also be changed to prohibit schools from expelling students because of their sexual orientation.
"Whether this goes through (parliament) or not, no child will be expelled because that's the experience - that children are not being expelled," Prime Minister Scott Morrison told his partyroom.
But the coalition resisted pressure from moderates and LGBTIQ+ groups to agree to further Sex Discrimination Act changes extending the same protection to gender diverse students.
The Australian Law Reform Commission will instead continue looking at whether s38 - which lets religious schools discriminate on additional grounds including gender identity, relationship status and pregnancy - should be more broadly overhauled.
One member told the partyroom they reserved the right to cross the floor on the legislation.
Liberal MP Bridget Archer told the House of Representatives she could not support bills because they eroded Tasmania's anti-discrimination laws and failed to protect transgender students.
"I'm horrified to see protections don't extend to students who identify as transgender," she said.
"In 2022 I can't believe we're even having this conversation … This bill is an overreach. In its current form I cannot support the bill."
Fellow Liberal moderate Dave Sharma remained concerned about protections for statements of religious belief and cited an aborted attempt by Brisbane's Citipointe Christian College to enforce a gender and sexuality contract.
"We should not be making young people's lives harder by allowing them to be discriminated against or vilified on account of attributes over which they have no choice," he told parliament.
Liberal MP Angie Bell earlier indicated she would support the legislation. She previously threatened to cross the floor unless it was amended.
Another coalition member told the partyroom of their opposition to legislating protection for transgender students on the grounds it risked undermining all girls' schools.
But other colleagues were disappointed with the limited changes and didn't understand why protections for gender diverse students, as well as LGBTIQ+ teachers, could not be addressed now.
Olympic swimming legend Ian Thorpe addressed media at Parliament House alongside Olivia, a year 12 student who identifies as transgender.
She spoke about being discriminated against at her former school after coming out.
"They told me I was very likely to be bullied by people … that my twin brother in the same year at the school would also be bullied. They told us that his leadership potential would be jeopardised," Olivia said.
"They said that if I would just leave this term, I would not have to pay the rest of the term's fees. This left me without a school going into the new year and with nowhere to go."
Labor is yet to finalise its position on the legislation.
Opposition leader Anthony Albanese told reporters: "If you work out what it is, let me know. Because I don't know what it is at this point in time".
Labor MPs and senators from two parliamentary inquiries last week offered their conditional support for the package.
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