Delhi High Court Sets Aside Rejection of Nil Withholding Certificate for Zscaler Inc After ITAT Rulings Disprove Permanent Establishment

In a significant relief for U.S.-based software major Zscaler Inc. , the High Court of Delhi has set aside the Assessing Officer’s (AO) refusal to issue a 'Nil Withholding Certificate' for the fiscal year 2025-26. A division bench comprising Justice V. Kameswar Rao and Justice Vinod Kumar directed the Department to reconsider the matter de novo , noting that the very foundation of the contested tax demand had been undermined by recent appellate findings.

Case Background

Zscaler Inc. , a non-resident entity providing software-based IT solutions, had applied under Section 197 of the Income Tax Act, 1961 , for a certificate enabling it to receive payments from its Indian clients without tax deduction at source (TDS).

The Revenue previously rejected this application, relying on assessment orders from Assessment Years (AY) 2021-22 and 2022-23. The tax authority’s position was that Zscaler maintained a 'Dependent Agent Permanent Establishment' (DAPE) in India through its Indian subsidiary, Zscaler Softech India Pvt Limited (ZSIPL) . Consequently, the Revenue attributed 25% of the gross software receipts as business income taxable in India.

However, the petitioner successfully challenged these assessment orders before the Income Tax Appellate Tribunal (ITAT) , Delhi. On June 18, 2025, the ITAT categorically held that ZSIPL did not constitute a DAPE and acted merely in a marketing support capacity, thereby nullifying the premise that Zscaler’s business income was taxable in India.

The Contentious Arguments

Representing Zscaler, advocate Kamal Sawhney argued that the Revenue failed to conduct any independent fact-finding for the current year. Instead, the AO relied solely on the assessment orders of preceding years—orders which have since been vacated by the ITAT. Citing the principle of consistency, the petitioner urged that in the absence of a change in circumstances, the Revenue cannot justify tax withholding on the presumption of a Permanent Establishment (PE).

Conversely, the Revenue, led by Senior Standing Counsel Sunil Agarwal, contended that Section 197 proceedings are provisional and tentative. The Revenue emphasized that the question of PE is fact-specific to each assessment year and that the ITAT's findings for prior years do not constitute res judicata for future periods. The Department further submitted that Zscaler’s business model—involving systematic sales to Indian end-users driven by a dependent subsidiary—satisfies the criteria for a PE under Article 5 of the India-USA Double Taxation Avoidance Agreement (DTAA) .

Key Observations

The judgment underscores the importance of the Tribunal's findings in administrative tax orders:

• Judicial Discipline: "The order of higher appellate authorities should be followed unreservedly and the mere fact that the decision is not acceptable to the Revenue cannot be a ground for not following the decision of the higher authority."
• Foundation of Evidence: "The conclusion of the AO in the assessment orders... has been set aside by the ITAT... and as such the very foundation for imposing the tax rate ceases to exist."
• Year-to-Year Scrutiny: The Court acknowledged that while taxability is often fact-specific to each year, the AO’s reliance on set-aside orders was procedurally flawed in the current context.

Court’s Decision and Future Implications

The Delhi High Court set aside the impugned certificates and orders dated May 2025. It mandated a de novo consideration, instructing the AO to conduct a fresh examination into the existence of a PE for the 2025-26 fiscal year without being influenced by the upcoming appeals the Revenue intends to file against the ITAT order.

This ruling clarifies that while Section 197 allows for a provisional view, tax authorities cannot insulate their orders from the impact of higher appellate court decisions. By mandating a hearing within three weeks, the court has prioritized procedural transparency and adherence to judicial discipline, setting a high bar for the Department when seeking to invoke PE-based taxation in the absence of current, validated evidence.