Facts of the Case

The petitioner, Zscaler Inc., a company incorporated in the United States of America, is engaged in providing cloud-based software solutions to customers in India through resellers and its Indian subsidiary, Zscaler Softech India Pvt. Ltd. For Assessment Years 2021–22 and 2022–23, the Revenue treated the Indian subsidiary as a Dependent Agent Permanent Establishment and taxed receipts as business income. These assessment orders were subsequently set aside by the Income Tax Appellate Tribunal by order dated 18.06.2025, holding that no DAPE existed in India.

For Financial Year 2025–26, the petitioner applied under Section 197 of the Income-tax Act for issuance of a Nil Withholding Certificate in respect of proposed receipts aggregating to approximately ₹1,319 crore. The Assessing Officer rejected the application and issued a certificate directing deduction of tax at 8.75%, relying solely on the assessment orders for AYs 2021–22 and 2022–23.

Issues Involved

Whether a withholding certificate under Section 197 of the Income-tax Act can be sustained when its sole basis is assessment orders that have been set aside by the ITAT, whether the Revenue can continue to assume existence of a Dependent Agent Permanent Establishment despite binding appellate findings to the contrary, and whether the principles of judicial discipline require the Assessing Officer to follow the ITAT order in Section 197 proceedings.

Petitioner’s Arguments

The petitioner contended that the entire foundation of the impugned withholding certificate was the assessment orders for AYs 2021–22 and 2022–23, which stood quashed by the ITAT. It was argued that in the absence of a Permanent Establishment in India, receipts from sale of software could neither be taxed as royalty in view of the Supreme Court judgment in Engineering Analysis Centre of Excellence nor as business income. The petitioner submitted that Section 197 proceedings require a prima facie view and that the Assessing Officer failed to conduct any independent examination for the relevant year, merely relying on non-existent assessment findings.

Respondent’s Arguments

The Revenue argued that orders under Section 197 are provisional and intended to safeguard revenue interests, that the existence of a Permanent Establishment is a fact-specific inquiry to be undertaken during regular assessment, and that the ITAT order does not operate as res judicata for subsequent years. It was also submitted that the Revenue was in the process of filing an appeal against the ITAT order and that the withholding certificate had already run its course for the relevant financial year.

Court Order / Findings

The Delhi High Court held that although Section 197 orders are provisional in nature, they must still be founded on a legally sustainable basis. The Court observed that the Assessing Officer had relied exclusively on assessment orders of preceding years to conclude existence of DAPE, and that those very assessment orders had been set aside by the ITAT. Applying the principle laid down by the Supreme Court in Union of India vs. Kamlakshi Finance Corporation Ltd., the Court held that orders of higher appellate authorities are binding on subordinate authorities unless stayed or set aside. The Court rejected the Revenue’s plea that a proposed appeal against the ITAT order justified continuation of the impugned withholding certificate.

Important Clarification

The Court clarified that while the Revenue is free to examine the issue of Permanent Establishment independently during regular assessment proceedings for the relevant year, it cannot ignore or bypass binding appellate findings while issuing certificates under Section 197. The Court also clarified that mere provisional nature of withholding orders does not legitimise reliance on a foundation that has ceased to exist in law.

Final Outcome

The writ petition was allowed. The withholding certificate dated 06.05.2025 and the orders dated 07.05.2025 and 16.05.2025 issued under Section 197 of the Income-tax Act were set aside. The matter was remitted to the Assessing Officer to reconsider the petitioner’s application for Nil Withholding Certificate afresh, in accordance with law and in light of the binding order of the Income Tax Appellate Tribunal.

Link to download the order - https://www.mytaxexpert.co.in/uploads/1769504120_ZSCALERINCVsDEPUTYCOMMISSIONEROFINCOMETAXCIRCLE311NEWDELHI.pdf

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