The 38-year-old Pearson was a firm favourite for a 10th gold medal of a stellar career in the Individual Championship Test - Grade Ib.
But Australian Formosa, 13 years Pearson's senior, had other ideas as a score of 75.826 per cent aboard Worldwide PB took her top of the leaderboard.
Pearson claimed the silver medal on Gentleman after scoring 75.391 per cent, with his amazing Paralympic winning streak finally ended after he secured gold medal hat-tricks at Sydney 2000, Athens 2004 and then Beijing 2008.
Austrian Pepo Puch - who was considered to be Pearson's main rival - collected the bronze on Fine Feeling with 75.043 per cent.
Formosa's victory was made all the more remarkable by the fact that she has only had her horse for seven months and was making her international debut on him.
But the Melbourne rider will now go down in Paralympic Games history as the first rider to beat Pearson.
'I think I will probably pass out when I realise what I have achieved,' she said.
'I came here to win. I wanted gold, and I knew my horse and I could do it because we are so passionate about it.
'This has been my goal all my life. The flame has been there in my heart, and I just love riding.'
While there was disappointment for Great Britain with Pearson's unexpected defeat, the Host Nation did have plenty to celebrate after Natasha Baker's 12-year dream came true.
Baker scored a Paralympic record 76.857 per cent on Cabral to claim the Grade II title, but only after a powerful twin German challenge fell just short
Defending Paralympic champion Britta Napel posted 76.048 per cent for second on Aquilina 3, with Angelika Trabert and Ariva-Avanti (76.000 per cent) third.
It was an emotional day for Baker, who fulfilled the vow made to her parents Lorraine and Phil in 2000.
'From the age of 10 when I watched the Sydney Paralympics on television I said I would come to a Paralympic Games and win a gold medal,' she recalled.
'But to come to my first Games and win gold, I never expected that in a million years.'