The theatre’s board approved a merger with the festival on Monday night.
It means the theatre takes over general management, with Hat Fair staff moving in with them.
But artistic director Kate Hazel, who remains creative boss, promised the festival would not lose its unique edge.
She said: “The Hat Fair will remain in terms of the three-day showpiece in July. “We are really excited about this year’s event and are at the centre of cutting-edge development.”
Theatre Royal director Mark Courtice added: “It would be a shame if this connection meant the Hat Fair came off the streets and that is not our intention at all.”
The pair said negotiations have been going on for several months after the two linked up on a mini Hat Fair for children project hosted by the theatre last July.
Mr Courtice said: “That work went well for us both and we felt it was a good step forward and at that time we thought we could work together.
“It became a logical thing to look at ways we could make the best of working together.”
He added the merger was for artistic rather than financial reasons.
Mr Courtice said: “This is about the long-term future of both organisations, rather than short-term answers to cuts.
“There is no long-term future if we cannot cope with cuts, so we know we are better able to cope together than if we are separate.
“But the fact is this was a fantastic opportunity to do all sorts of exciting things, and both our roles are to provide Winchester with the best performances inside and outside.”
He also confirmed the theatre would not be funding the Hat Fair.
But Ms Hazel said the Hat Fair would have had to work on a smaller scale had the merger not happened.
She said: “It’s difficult to say for sure what would have happened to Hat Fair without this, but I think it would have looked smaller and there probably would have been less going on.
“We are working in a climate where every week there is more news about cuts to arts funding, and what we are endeavouring to do here is to make sure we are building a secure future for both organisations.”
She added the Hat Fair would now be able to offer year-round events, including a summer season from May to September, beginning with the Emerge Festival in May, working with the University of Winchester to showcase up-and-coming talent.