AO's Withholding on Software Receipts Nullified by ITAT Ruling on No PE: Delhi HC Grants Relief to Zscaler Inc [Read Order]

In a recent ruling, the Delhi High Court has provided relief to a US‑based technology company, Zscaler Inc., by quashing the Assessing Officer’s(AO) order that imposed an 8.75% withholding tax on its software receipts from Indian clients, holding that the order, issued under Section 197 of the Income Tax Act, 1961, was unsustainable because it relied entirely on assessment orders for earlier years that had already been set aside by the Income TaxAppellate Tribunal (ITAT).

Zscaler Inc, a non‑resident entity engaged in providing cloud‑based software solutions, had applied for a Nil Withholding Certificate for payments amounting to over ₹13,000 crore. The AO rejected the application and directed that tax be withheld at 8.75%, attributing 25% of Zscaler’s Indian revenues to a Dependent Agent Permanent Establishment (DAPE) allegedly constituted through its Indian subsidiary, Zscaler Softech India Pvt. Ltd.

The reason provided by AO was based on assessment orders for AYs 2021–22 and 2022–23, which had treated Zscaler’s receipts as taxable business income in India.

However, the ITAT, in an order dated June 18, 2025, had already held that Zscaler India did not constitute a DAPE of the parent company. The Tribunal found that the Indian subsidiary was only providing marketing support services, and as such, the very foundation for imposing the tax rate ceases to exist. This ruling directly eroded the AO’s dependence on the earlier assessments.

The counsel for the respondent submitted that in a case of this nature, as the interest of the

Revenue is paramount; in the event tax liability comes into existence subsequently, the Revenue should not be left remediless.

It was observed that the submission of respondent counsel was that the Revenue is in the process of Filing an appeal against the order of the ITAT is of little help to the Revenue, as the law in this regard has been quite well settled by the Supreme Court in the case of Union of India v. Kamlakshi Finance Corporation Ltd, (1991), wherein it was held that 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.

Since the ITAT had altogether held that no PE existed for Zscaler in India, the very foundation of the AO’s withholding order collapsed.

The Court also noted that the characterisation of software receipts has undergone a major shift following the Supreme Court’s landmark ruling in Engineering Analysis Centre of Excellence v. CIT (2021). That judgment provided clarity that payments for resale of copyrighted software copies do not constitute “royalty” under Article 12 of the India‑US Double Taxation Avoidance Agreement (DTAA).

Zscaler depended on this precedent to argue that its software receipts were not taxable as royalty, and absent a PE, they could not be taxed as business income either.

The AO’s overview of profits was also criticised as arbitrary. By applying a flat 25% margin to Zscaler’s Indian revenues, the AO arrived at an actual withholding rate of 8.75%. Zscaler argued that attribution must follow a settled formula based on functions performed, assets used, and risks assumed by the alleged PE. In the absence of a PE, no attribution exercise was permitted at all.

The Division bench of Justice V Kameshwar Rao and Justice Vinod Kumar agreed that Section 197 certificates, though provisional in nature, must be based on a prima facie assessment of facts and law. They cannot ignore any binding appellate decisions or depend solely on past assessments that have been invalidated.

The Court directed the AO to reconsider Zscaler’s application de novo, taking into account the ITAT’s findings and wanted Zscaler to furnish relevant agreements and financial documents for the current year.

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