Police claim Ali Khalif Shire Ali, 20, planned to get his hands on an automatic rifle and shoot as many people as he could during celebrations at Federation Square - where thousands gather every December 31 to watch fireworks, the BBC reported.
"What we will be alleging is that he was intending to use a firearm to shoot and kill as many people as he could", said Victoria Police deputy commissioner Shane Patton, on Tuesday.
The 20-year-old was arrested by at a house in Werribee about 3pm on Monday by Victoria Police, Australian Federal Police and ASIO officers.
But there is "no ongoing threat to the public", they said.
Police expect him to appear at Melbourne Magistrates Court later today or the early hours of tomorrow.
Police accuse Ali of trying to obtain a guide made by Al-Qaeda that tells followers how to perpetrate extremist attacks with deadly weapons, but he was detained before he could purchase an automatic rifle.
"The potential of the attack was catastrophic", said Patton.
The Australian-born man, whose parents are from Somalia, once claimed he was approached by intelligence operatives in 2015 and asked to spy on suspected terror plotters, The Age reported.
Police do not anticipate further arrests.
"Absolutely police were aware of this very early and had been monitoring", she said.
"I can absolutely assure Victorians that this has eliminated the risk", she said.
Police take down terror suspect Ali Ali.
The man arrested by counter-terrorism police over a planned New Year's Eve attack in Melbourne meant to shoot as many people as he could, police will allege.
Specialised squads including Water Police, Mounted Branch, Operations Response Unit and Air Wing were deployed across the state.