The treaty was brokered by the Conciliation Commission established under the UN Convention on the Law of the Sea (UNCLOS).
The nation wants to build a processing hub on its southern coastline, but Australia is deeply sceptical about East Timor's capacity to develop the plant.
East Timor, with a population of 1.3 million, is among the poorest countries in the world.
Signed by Australian Foreign Minister Julie Bishop and Timor-Leste Minister in the Office of the Prime Minister for the Delimitation of Borders, Hermenegildo Augusto Cabral Pereira, at the UN headquarters in NY in the presence of UN Secretary-General Antonio Guterres, the pact marks the successful conclusion of the first recourse to conciliation proceedings under the United Nations Convention on the Law of the Sea.
The treaty ends a long a bitter dispute between the neighboring countries and paves the way for exploitation of billions of dollars in gas and oil under the Timor Sea - with at least 70 percent of the revenue to go to impoverished East Timor.
Timor-Leste's chief negotiator Xanana Gusmao said: "History is made today as Timor-Leste signs a treaty on permanent maritime boundaries that establishes, for the first time, a fair border between our two countries, based on global law". "And it was important to both Australia and Timor Leste to achieve successful results", he said. The Indonesian border with Australia extends east and west of the new East Timor-Australia boundary and the vast expanse Indonesia allowed Australia is a source of increasing irritation for the Indonesian government.
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East Timor's oil revenues finance about 90 percent of government spending, but are running out due to the exhaustion of existing fields. However, previous year Australia agreed to terminate the original agreement, reigniting development plans.
The rival border options became the north and south edges of a box called the Joint Petroleum Development Area. The first boundary is drawn along the Australian continental shelf and determines the ownership of resources found within the seabed while the second is drawn along the median line between Australia and Indonesia and determines the ownership of the resources found within the water column.
It is hoped the deal, signed at the United Nations in NY, will end the bitter dispute over oil and gas reserves in the Timor Sea.
Australia and East Timor signed a 2006 treaty on sharing future Greater Sunrise revenue.
East Timor's negotiating team was led by independence hero Xanana Gusmao, the nation's first president. "We had ups and downs in this 22, 23 months", said Pereira, according to Reuters.
This story was reported by the Associated Press.