A photo posted to social media by the Timaru District Council shows one side of the tree in the city centre has been scorched.
Police were called to the scene at Caroline Bay Piazza about 5.30am on Friday.
Officers arrested a 30-year-old man who is due to appear in court on Friday. He is facing charges including arson and possessing a knife in a public place.
The district council said the tree has suffered significant fire damage and will have to be removed this year.
It said the tree will not be replaced this year.
"We'll be getting in touch with our insurers and looking into options going ahead," the district council said.
Timaru district mayor Nigel Bowen said it was a shame the tree had been so badly damaged.
"Our community was disappointed to wake up this morning to hear our town's Christmas tree has been damaged due to a fire," he said.
"This tree has brought lots of joy to our community in the few years we've had it and it's really, really sad that someone has decided to deprive the community of it through a stupid and destructive act."
The mayor said he was disappointed locals and visitors won't be able to continue the tradition of taking family photos in front of the tree.
"Although the tree is a symbol of Christmas we can't get past the fact that it is a place of joy and connection for our community," Bowen said.
"The tree will be removed today, the area will be cleaned up and we will start the insurance process. We will also be providing police and Fire and Emergency New Zealand with any assistance they require in their investigations."
The Christmas tree's height includes the star, weighs around 7000kg with the base, and features a 275-metre string lights.
