Pioli left Milan after the 19-time Italian Serie A champions finished second last season, 19 points behind champions Inter Milan, and following lacklustre runs in the Champions League and the domestic cups.
Fonseca, 51, last managed French side Lille and guided them to a fourth-placed finish in Ligue 1 last season.
"AC Milan can confirm that Paulo Fonseca has been appointed as the head coach of the men's first team," the club said in a statement on Thursday.
"The club would like to wish Paulo and his staff a warm welcome."
Fonseca started his managerial career with the youth team of Estrela Amadora in 2005 before taking charge of FC Porto in 2013, followed by stints with Braga and Ukrainian side Shakhtar Donetsk.
He won the Portuguese Super Cup with Porto in 2013, the Cup of Portugal with Braga in 2015-16, as well as the Ukrainian Premier League with Shakhtar Donetsk three times in a row.
It brings the total of fresh appointments in Italy's top flight to three in a space of 24 hours.
Juventus confirmed Thiago Motta as Massimiliano Allegri's replacement, while Alessandro Nesta takes over as boss at Monza.
In Germany meantime, Borussia Dortmund head coach Edin Terzic has announced he will leave the club with immediate effect after requesting his contract be terminated.
Edin Terzic has called time on his coaching stint at Borussia Dortmund. (AP PHOTO)
"Borussia Dortmund and coach Edin Terzic are going their separate ways. The 41-year-old asked BVB to terminate his contract immediately. Borussia Dortmund agreed to the request after a joint discussion," the club said in a statement.
The 41-year-old won the German Cup with Dortmund in 2021 as interim coach, helped them finish runners-up in the Bundesliga in 2023 and reached the Champions League final in 2024 when in permanent charge.
"It is incredibly painful for me to say this to all Black and Yellow fans, but today I am parting company with Borussia Dortmund," Terzic, a boyhood Dortmund fan, said.
"After the game at Wembley, I asked for a meeting with the club's senior management team, because after 10 years at BVB - including five on the coaching staff and two and a half as head coach - I feel that the club's new era should begin with a new man on the touchline."
With DPA.
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