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There is no compulsion in religion. Verily, the Right Path has become distinct from the wrong path. Whoever disbelieves in Tâghût and believes in God (ar. Allah), then he has grasped the most trustworthy handhold that will never break. And God is All-Hearer, All-Knower.
A famous letter sent by 36 Islamic scholars to Pope Benedict XVI addressed this verse:
"this verse is acknowledged to belong to the period of Quranic revelation corresponding to the political and military ascendance of the young Muslim community. ‘There is no compulsion in religion’ was not a command to Muslims to remain steadfast in the face of the desire of their oppressors to force them to renounce their faith, but was a reminder to Muslims themselves, once they had attained power, that they could not force another's heart to believe. There is no compulsion in religion addresses those in a position of strength, not weakness. The earliest commentaries on the Qur'an (such as that of Al-Tabari) make it clear that some Muslims of Medina wanted to force their children to convert from Judaism or Christianity to Islam, and this verse was precisely an answer to them not to try to force their children to convert to Islam."
Invasion of Banu Nadir 
According to Islamic tradition, this verse was revealed by the Angel Gabriel to Muhammad during the Invasion of Banu Nadir. World religions and norms of war, a book published by the United Nations University, states that Quran 2:256: "there is no compulsion in religion" was mentioned about this event, the books quotes the Sunan Abu Dawud hadith below:
When the children of a woman (in pre-Islamic days) did not survive, she took a vow on herself that if her child survives, she would convert it a Jew. When Banu an-Nadir were expelled (from Arabia), there were some children of the Ansar (Helpers) among them. They said: We shall not leave our children. So Allah the Exalted revealed; "Let there be no compulsion in religion. Truth stands out clear from error." Sunan Abu Dawood, 14:2676
The Quran commentator (Muffasir) Ibn Kathir wrote about it:
There is no compulsion in religion. Verily, the right path has become distinct from the wrong path. لاَ إِكْرَاهَ فِي الدِّينِ (There is no compulsion in religion), meaning, "Do not force anyone to become Muslim, for Islam is plain and clear, and its proofs and evidence are plain and clear. Therefore, there is no need to force anyone to embrace Islam. Rather, whoever Allah directs to Islam, opens his heart for it and enlightens his mind, will embrace Islam with certainty. Whoever Allah blinds his heart and seals his hearing and sight, then he will not benefit from being forced to embrace Islam. It was reported that; the Ansar were the reason behind revealing this Ayah, although its indication is general in meaning. Ibn Jarir recorded that Ibn Abbas said (that before Islam), "When (an Ansar) woman would not bear children who would live, she would vow that if she gives birth to a child who remains alive, she would raise him as a Jew. When Banu An-Nadir (the Jewish tribe) were evacuated (from Al-Madinah), some of the children of the Ansar were being raised among them, and the Ansar said, `We will not abandon our children.' Allah revealed, لاَ إِكْرَاهَ فِي الدِّينِ قَد تَّبَيَّنَ الرُّشْدُ مِنَ الْغَيِّ (There is no compulsion in religion. Verily, the right path has become distinct from the wrong path). Abu Dawud and An-Nasa'i also recorded this Hadith. As for the Hadith that Imam Ahmad recorded, in which Anas said that the Messenger of Allah said to a man, أَسْلِم "Embrace Islam. The man said, "I dislike it. The Prophet said, وَإِنْ كُنْتَ كَارِهًا "Even if you dislike it. First, this is an authentic Hadith, with only three narrators between Imam Ahmad and the Prophet. However, it is not relevant to the subject under discussion, for the Prophet did not force that man to become Muslim. The Prophet merely invited this man to become Muslim, and he replied that he does not find himself eager to become Muslim. The Prophet said to the man that even though he dislikes embracing Islam, he should still embrace it, `for Allah will grant you sincerity and true intent.'
- Open Letter to his holiness Pope Benedict XVI (PDF)
- Vesselin Popovski, Gregory M. Reichberg, Nicholas Turner (2009). World religions and norms of war. United Nations University Press. p. 296. ISBN 9789280811636.
- Tafsir Ibn Kathir Part 3: Surah Al-Baqaray, Ayat 253 to 286, Surah Al-Imran, Ayat 1 to 92, by Ar-Rafa'i, Muhammad Nasib, Al-Firdous Ltd., London, 1999: First Edition, Part 3, pp. 37-38
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