Donley, a 21-year-old Northern Ireland international, becomes Jack Wilshere's sixth signing of the summer after the Luton manager made the midfielder a long-standing target.
"Jamie's a quality player and someone who we have kept our eye on since January. He went to the Championship with Oxford, but we've maintained a relationship with him," Wilshere said.
"One thing we've done really well in this window is that we've had targets we wanted to go after.
"We knew the positions we wanted to improve or add depth in, and Jamie's definitely been top of that list for a long time, so to get it done feels like a really important signing."
Donley, who has previously spent loan spells at Leyton Orient, Stoke City and Oxford United, gives Luton a left-footed option in the middle of the park as well as an attacking threat further forward. Wilshere revealed that a friendship with Luton goalkeeper Josh Keeley, a former Spurs team-mate, helped seal the move.
"It's one thing coming from a manager. But then to speak to a good friend, someone who he was with at Spurs and Leyton Orient, who he trusts and who obviously only said good things about the environment and how we work, I think it's credit to everyone at the club for creating that," he said.
Donley, speaking after finalising his medical, said: "I'm over the moon. It's taken a while, but I'm delighted to get it done and excited to see what I can do this season. When the manager called me, he spoke very highly of me, about what he wants to do this season and the way they play football. That's all you want to hear as a player, and hopefully I can take on that advice and show him that what he believes in me, I can do."
Elsewhere at Tottenham, 20-year-old centre-back James Rowswell is attracting interest from several League One clubs over a possible loan before Tuesday's deadline. Spurs are open to letting him leave to gain senior game time, and although four clubs registered interest at the start of the summer, talks were paused after a foot injury disrupted his pre-season.
With Rowswell now fit again, negotiations have resumed with three of those sides, though no agreement is yet in place.
A product of the Tottenham academy, Rowswell signed a new contract in April shortly after making his Premier League debut in a 1-1 draw at Liverpool in March, and his preference remains to leave on loan, though staying at Spurs has not been ruled out.