The devs said in the patch video that this was implemented as way to prevent using domination to take advantage of the diplomatic victory path. The idea is that a big empire that has eliminated the competency of other civs, should have a weak diplomacy, as it would be hated by the rest of the world. The idea is completely unrealistic but makes more sense balance wise, as aggression was making the diplomatic victory too easy.
Therefore it is to me obvious that this is a mechanic introduced for balance, to punish the advantages of agressive gameplay in diplomacy.
Thus I can only conclude that loyality flipping should not be punished. Also taking into account the words of the devs, and the spirit of the main diplomatic mechanics of the game. The fact that the system does not consider the current age, and applies a permanent DF penalty modifier for being aggressive, before WC, grievances or actual diplomacy applies in the game, is also a bug, as breaks balance and violates the rules of the game.
Other aspects of the penalty, making it constant and independent of the context (who started the war, if the capital was taken from his owner, or even if the original owner is still in game...) or razing various cities having less penalties that occupying one. Contradict also the way diplomacy is presented in the game, but I think these specific issues can be attributed to a case of lazy impplementation and lack of care were maybe balance should be requested, but are not a bug.
An aspect that falls in between bug and poor implementation is that the domination path now removes efectively the WC and the competitions from the game, even for a player that plays the way the game is supposed to be played: being at war at early ages, so you remove maybe two enemies before turning to a more peaceful strategy for the rest of the game. If you do this now, you will never be able to participate properly in a WC session, or to use the favor earned in competitions except for selling it inmediatly; as you will have a permanent negative per turn DF. But still you will be forced to endure these mechanics as a chore. This is obviously not intended behavior. And the devs need to remove warmonger players from WC and competitions, and/or balance down the penalty.
As I side note, I think the penalty should be applied for wipping civilizations, not occupying capitals, and/or that an option to keep conquered cities as puppets with less penalty applied should be implemented to balance this mechanic (and because domination needs desperately, a way to iron out the tedium of city micromanagement).
