Shunt reactor with auxiliary windings (SRAW) can compensate inductive reactive power for long‐distance transmission lines and supply steady power for low‐voltage devices on offshore platforms. The operation characteristics of SRAW can be commonly described by the air‐core transformer equivalent model. However, this model can only make an approximate simulation of the external characteristics of SRAW, and cannot reflect the actual electrical features inside the SRAW. To solve this problem, the authors propose a three‐segment magnetic circuit equivalent model (TMCEM) of SRAW based on the magnetic circuit decomposition method. This model can accurately describe the coupling relationship inside SRAW and can be used for the analysis of internal fault characteristics. Furthermore, through the fault analysis utilizing TMCEM, a novel protection scheme of SRAW based on virtual magnetizing differential current is proposed for the detection of the inner‐turn fault in SRAW. This protection scheme has high sensitivity and can effectively identify the inner‐turn faults without measuring voltages. By testing the physical model of SRAW, the effectiveness of the TMCEM and the proposed protection scheme against inner‐turn fault has been confirmed.