The website, which has about 100 million users, with roughly a third of those uploading a total of five million images a day, was acquired by Facebook in April 2012 for $1bn (£616m).
In its controversial new policy, which has been slammed by its users, it said that users would have to "agree that a business or other entity may pay us to display your username, likeness, photos and/or actions you take... without any compensation to you".
In response, a blog from Instagram co-founder Kevin Systrom, entitled ‘Thank you, and we're listening', states that "it was interpreted by many that we were going to sell your photos to others without any compensation. This is not true and it is our mistake that this language is confusing. To be clear, it is not our intention to sell your photos".
Systrom said that Instagram was working on updating the language in the terms and conditions to make them clearer.
The new usage policy had also said that Instagram "may share [users'] information as well as information from tools like cookies, log files, and device identifiers and location data with organisations that help us provide the service to you [as well as] third-party advertising partners".
Systrom denied users' photos could be part of an advertisement.
"We don't have plans for anything like this," he said.
"Our main goal is to avoid things like advertising banners you see in other apps that would hurt the Instagram user experience," he added.
He insisted that users own their photos and content and Instagram does not claim any ownership of photos. He added that the privacy settings would also remain the same as before.
However, Systrom did say that Instagram would use its userbase for "engagement" purposes.
"Let's say a business wanted to promote their account to gain more followers and Instagram was able to feature them in some way. In order to help make a more relevant and useful promotion, it would be helpful to see which of the people you follow also follow this business. In this way, some of the data you produce - like the actions you take (eg, following the account) and your profile photo - might show up if you are following this business," he said.
The new policy is to come into force on 16 January 2013, which Systrom said would give users time to raise any concerns they have with the terms and conditions.
Many users have already tweeted that they plan to use a different photo-sharing service.
Twitter itself has launched a native photo filtering product to rival Instagram. The updated Twitter app for iOS and Android was launched just a few days after Instagram revoked its access to Twitter.