"This suggests that our companies doing business abroad are stocking up their business profits instead of paying out dividends," Im Dong-won, a KERI researcher, said.

To boost domestic economy, South Korea needs a positive structure in which these companies circulate the profits from overseas to their home country, Im said. "As an incentive, we need to modify the taxation system."

Unlike most of the member states of the Organization for Economic Cooperation and Development, South Korea has a residence-based taxation system, under which companies are taxed at home for their global income. Twenty-eight of the 34 OECD member countries employ source-based taxation, which taxes only locally earned profits.

"Under a residence-based system, companies are likely to keep their earnings at their offshore bases to avoid taxation at home," KERI said. "This not only undermines taxation neutrality and leads to ineffective investment, but also creates the problem of business profits not being returned to the country."

Shifting to source-based taxation would induce companies to bring back the money, and at the same time further raise South Korea's competitiveness in attracting multinational companies, KERI said.

The institute cited as a good example the case of Japan, where a change to source-based taxation in 2009 helped more than double the dividend payment rates by offshore companies. The rate of profit returns to the home country spiked, which was used for research, facility investment and employment, the institute said. (Yonhap)