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Ottawa’s plans to pull billions of additional dollars from banks and insurers signals a concerning shift as the federal government increasingly turns to the financial sector for revenue, analysts say.

In the federal budget Tuesday, the Liberals unveiled the amendment to tax rules on dividends that financial institutions receive from Canadian companies. The measure is expected to generate $3.15-billion over five years starting in 2024, and $790-million annually after that.

Banks and insurers have been allowed to exclude dividends from their business income, enabling them to lower their tax burden, the government said in its budget. The latest change requires financial companies to account for dividends of Canadian shares that they hold – which lawyers say could create multiple layers of taxation.

The change could cause a modest hit to earnings per share this year by slightly less than 1 per cent, but the broader sentiment from government marks a “worrying trend,” according to Keefe, Bruyette & Woods analyst Mike Rizvanovic.

It’s the second consecutive major shift in taxation for the financial sector since last year’s budget, which introduced two substantial tax initiatives.

“While the financial impact of the new measures appears modest, it provides yet another reason for Canadian bank investors to be concerned about the government’s approach in taxing the sector,” Mr. Rizvanovic said in a note to clients. “The government’s approach will weigh on sentiment for the sector with investors likely wondering about what other potential measures could be introduced in the years ahead.”

Many of the banks are contesting the change, National Bank of Canada NA-T chief financial officer Marie Chantal Gingras said during a banking conference Wednesday morning.

“It was a bit of a surprise on the dividend front,” Ms. Gingras said. “Our very first initial estimate is that it’s really non-material, maybe approximately 1 per cent of our revenue.”

Because dividends are paid from a corporation’s after-tax income, shareholders who receive those dividends are generally exempted from paying another round of taxes on them, according to Adrienne Oliver of Norton Rose Fulbright Canada LLP, regardless of whether those shareholders are other corporations or individual investors.

“Ideally the system works so that there is only one level of tax throughout that whole stream of distributions of after-tax income,” Ms. Oliver, a tax partner and chair of the firm’s Toronto business law group, said in an interview. “This change is absolutely inconsistent with a pretty fundamental tax policy concept.”

The change not only appears to have been a last-minute addition to the budget, according to tax lawyer Timothy Hughes, but implementing the change could also violate a legal principle that has been in place for more than a century.

“The intercorporate dividend deduction that prevents corporate earnings from being taxed twice when they are distributed to another corporation has been a feature of the Canadian tax system since the Income Tax War Act of 1917,” Mr. Hughes, who leads the capital markets tax practice at Osler Hoskin and Harcourt LLP, said in an interview. “The view was it would be tantamount to double taxation if that wasn’t there.”

In the 1994 federal budget, the government added mark-to-market rules for securities held by financial institutions, meaning banks and insurers had to start reporting losses or gains in their portfolios every year and pay the appropriate tax. Normally, gains or losses on securities are only subject to tax rules if they are sold.

“There are already specific rules in the Act that contemplate dividends being received on those types of securities by financial institutions, they’re there,” Mr. Hughes said. “We’ve had the non-double-tax principle since 1917, we’ve had mark-to-market rules since 1994 and then yesterday the Department of Finance said those two things don’t go together, so it was very surprising to me.”

Ottawa will likely face widespread opposition to the proposed change, Ms. Oliver said, since shares of major banks and insurers are so broadly held by individual Canadian investors either directly or indirectly, “this is a cost that is going to be borne by [them].”

Investors did not appear immediately concerned by the new measure, with shares of Canada’s five largest banks all moving slightly higher over the course of the Wednesday trading session. The Canadian group followed climbing U.S. bank stocks amid waning fears that three major bank failures could stoke further contagion. The KBW Bank Index rose 2.1 per cent on Wednesday.

Last year’s budget introduced two new charges for the sector. The Canada Recovery Dividend required large banks and life insurers to pay a temporary 15-per-cent tax on taxable income above $1-billion for 2021. It is expected to raise $604-million annually starting in 2022, for a total of $3.02-billion over five years, according to estimates by the Parliamentary Budget Officer in September.

The government also unveiled a permanent change to the sector’s corporate income tax rate that raises an estimated $2.25-billion over five years. It increases the tax rate by 1.5 percentage points to 16.5 per cent on taxable profits over $100-million.

Bank of Nova Scotia analyst Meny Grauman said that banks and insurers have seen their annual tax burden jump by a combined $2.5-billion over the past two budgets.

“This rising tax burden on Canadian financials clearly points to a less favourable domestic operating environment, an environment that for the large Canadian banks is also being negatively impacted by higher minimum capital ratios,” Mr. Grauman said in a note to clients. “Although all of these items are small in and of themselves they should increasingly weigh on valuations as they appear to be becoming a more regular occurrence.