The 28-year-old, who played for the county in 2003, will join fellow New Zealander James Franklin in the squad.
The move also links Butler with former New Zealand coach and offspin bowler John Bracewell, who is Gloucestershire's director of cricket.
Bracewell told the BBC website Butler's death bowling and ability to whack boundaries will be a "huge asset to the squad".
"When Ian broke down with a recurring back injury, he actually reinvented himself as a batter and came back and played in twenty/20 games solely as a batter," Bracewell said.
"His back has recovered and he's now developed some all-round skills.
"That's really handy in the middle in terms of power that we perhaps lacked a little last year.
"It gives us a more rounded side.
"We'll be looking to use his short bursts of big hitting, probably playing other batters in and around him"Butler was the leading wicket-taker for Otago in the domestic twenty/20 tournament, with 14, at an average of 12.78, and he chipped in with 96 runs at 24.
He has played eight tests, 26 ODIs and 14 twenty/20 internationals.
New Zealand and Otago top-order batsman Brendon McCullum will ply his trade with the defending champion, Sussex.
He replaced Sri Lankan dasher Tillakaratne Dilshan.
According to the Guardian newspaper's cricket blog, Brendon's older brother, Nathan McCullum, could be on his way to play for Lancashire, setting up a sibling rivalry.
Nathan is reportedly being considered as a replacement for Pakistan all-rounder Shoaib Malik.
Nathan has previously played league cricket for Lancashire.
McCullum declined to comment when contacted yesterday.
Seven other Otago cricketers are summering in the northern hemisphere.
Wicketkeeper-batsman Derek de Boorder is in the Netherlands, playing for club side Hermes-DVS.
Top-order batsman Hamish Rutherford is in Scotland, Leighton Morgan, Brendon Domigan, Mark Joyce and Shaun Fitzgibbon are in England and Sean Eathorne is also in the Netherlands.
