The former Falkirk midfielder makes the switch after five seasons with Burnley, helping them to promotion and European football for the first time in over 50 years.
The 29-year-old, who initially joined Huddersfield Town from the Bairns in 2010, has been capped 12 times for Canada, scoring once, despite featuring 17 times for Scotland Under-21s.
Arfield, who was linked with a move to Ibrox in January and again last month, is the first signing of the Steven Gerrard regime, and the new Light Blues boss welcomed the acquisition of the midfielder.
Gerrard said: “I am delighted to have added Scott Arfield to the squad for next season.
“He is a talented and competitive midfielder who has competed at a high level in the English Premier League and internationally for Canada.
“It’s pleasing also that we have been able to start our rebuilding process so quickly after the end of the season.
“There is much more to be done of course as we look to build towards our Europa League campaign which will start in early July.
“Scott is the first one in and I look forward to working with him and the others who will be coming in to strengthen the squad.”
Arfield said: “As soon as the interest came in, it was something I wanted to go for.
“When a club of this magnitude comes in for you it’s a no-brainer.
“I’m excited to work with Steven Gerrard - if you don’t get excited by that you shouldn’t walk through the front door. [His appointment] has given a boost to the whole game in this country.”