It also wants uniform penalties between basin states for irrigators who don't comply with regulations.
The South Australia-based 736-page final report, released more than a year after allegations of water theft were revealed, includes 111 findings and 44 recommendations aimed at improving the effectiveness of the Murray-Darling Basin Plan.
It says the Murray-Darling Basin Authority acted unlawfully when it "completely ignored" climate change projections for the determination of water allocations.
"The (sustainable diversion limit) ignores the best available scientific knowledge," it says. "As an administrative decision, it is indefensible."
South Australian Premier Steven Marshall said the commission had strayed from its initial aim.
"I note that when the royal commission was announced by the former state Labor government, South Australians were told the commission's focus would be investigating allegations of water theft in the Murray-Darling Basin," he said.
"This was not by any means the focus of this inquiry."
Mr Marshall addressed the media and said he would review the recommendations and respond accordingly.
"I'm not an environmental scientist. I'm not a water scientist. I don't want to be drawn on providing commentary at this early stage," Mr Marshall said.
"But I can assure every single person in this state, we are taking this royal commission report extraordinarily seriously."
The Commissioner Bret Walker SC has recommended a complete overhaul of the Murray-Darling Basin Plan.
Earlier today, Agriculture Minister David Littleproud said he was adamant the plan was legal.
"The premise that the government and I understand the opposition, is working on is that the Murray-Darling Basin Plan is legal," Mr Littleproud told ABC's Radio National.
He said he had consulted with the Attorney-General's department earlier in the week, as the government prepared for the report's release.
Mr Littleproud said the federal government would respect the commission's findings.
The Murray-Darling system takes in 23 rivers, supports more than four million people and stretches across South Australia, Victoria, NSW and Queensland. The Plan determines the amount of water that can be taken from the basin for urban, industrial and agricultural use.