What the Zscaler Ruling Teaches Us About Section 197, Withholding Tax, and Permanent Establishment in India When Tax Authorities Get It Wrong
There aren’t many tax conflicts in cross-border commerce since corporations don’t want to pay taxes. They happen because the rules are hard to understand, people have different ideas about what they mean, and judgements made at one stage often have effects for years. Withholding tax on payments made to non-residents is a common problem for multinational businesses doing business in India. This is especially true when tax authorities assume that there is a Permanent Establishment (PE) without looking at the facts of the current year.
The Delhi High Court’s recent and crucial decision in Zscaler Inc. v. Deputy Commissioner of Income-tax has made this problem considerably clearer. The ruling does more than just give the taxpayer immediate relief; it also sends a strong message about how Section 197 petitions should be handled, how results from previous years can’t be blindly reused, and why factual discipline is important when claiming a Dependent Agent Permanent Establishment (DAPE).
This essay breaks down the ruling, explains the legal principles in plain terms, and shows how they apply to the business and compliance issues that multinational firms make every day.
Why Section 197 is So Important: A Background
Before we get into the judgement, let’s talk about why Section 197 of the Income-tax Act, 1961 is so vital for cross-border transactions.
Section 197 lets a non-resident (or the Indian payer) ask for a certificate that lets them not pay or pay less tax when the income is either not taxable in India or taxable at a lesser rate than what the payer would have to pay under Section 195. This certificate is not just a nice-to-have for international companies who get big payments from India; it has a direct impact on cash flow, pricing, and the ability to do business.
Indian payers routinely take too much tax off their payments without a Section 197 certificate. Sometimes, they take off far more than what the law says they should. It can take years to get that extra money back through refunds. That’s why both taxpayers and tax authorities often fight hard over Section 197 petitions.
In Simple Terms, the Zscaler Dispute
Zscaler Inc. is a US-based company that sells software-based IT solutions to customers in India. In the past, it paid taxes in India based on royalties. After the Supreme Court’s important decision in Engineering Analysis Centre of Excellence, which made it clear that selling ordinary software is not “royalty,” Zscaler revised its tax position and said that its software income was not taxable in India.
The tax department did something else in response. Instead of taxing the income as royalty, it said that Zscaler had a Dependent Agent Permanent Establishment (DAPE) in India through its Indian subsidiary, Zscaler Softech India Pvt. Ltd. Because of this, it counted the receipts as business income that was taxable in India.
For the years before (AY 2021-22 and 2022-23), the Assessing Officer issued assessment orders saying that a DAPE existed. But the Income Tax Appellate Tribunal later threw out these decisions, making it clear that the Indian subsidiary was merely providing marketing support services and was not a PE.
Even yet, when Zscaler asked for a nil withholding certificate under Section 197 for AY 2025-26, the Assessing Officer turned it down and told them to withhold 8.75% based only on the assessment orders that had already been reversed.
The Delhi High Court heard an appeal against this rejection.
The Main Legal Issue in Court
The High Court was not required to judge if Zscaler had a PE in India this year based on the facts. The question that was narrower but more forceful was this:
Can the tax office turn down a Section 197 application just because of earlier assessment orders that the Tribunal has already set aside?
The Court’s response was a plain and unequivocal no.
Why the High Court’s Reasoning Matters So Much
The Delhi High Court said that the Section 197 rejection was no longer valid because the Tribunal had thrown down the earlier assessment orders that said there was a DAPE. The Assessing Officer couldn’t keep using results that the law said didn’t exist anymore.
It may seem obvious, but in practice, tax authorities typically see Section 197 actions as just an extension of past years, with no new look. The Court made it plain that this kind of approach is not allowed.
The decision strengthens three important ideas.
1. Each Assessment Year Is Distinct—Even During the Withholding Phase
It is a well-known truth that each assessment year has its own collection of facts. The Court said again that this rule extends to temporary actions like Section 197.
The tax agency must look at the facts of that year if it thinks a PE exists. It cannot presume continuity just because it said there was a PE in the past, especially because an appellate authority has already said that claim is not true.
This is very important for global organisations whose business models change over time. Every year, the way marketing works, the way resellers work, and the way contracts are set up change a little bit. Treating the existence of PE as a permanent label undermines the factual basis of PE analysis.
2. Section 197 is temporary, but not random.
The Revenue said that Section 197 actions are temporary and aimed to preserve the interests of the revenue. The Court agreed with this in general, but with one key caveat.
Yes, there are withholding rules in place to protect revenue. But provisional doesn’t mean mechanical. Even a prima facie view must be founded on valid, existing evidence. If the Tribunal has thrown out all of the evidence used, the Assessing Officer must start over.
This is a good compromise between protecting revenue and being fair to taxpayers. It stops the authorities from using Section 197 as a blunt tool to coerce people to withhold money without a lawful reason.
3. Judicial Discipline Is Not Optional
One of the best things about the judgement is that it reaffirms the need of judicial discipline. The Court based its decision on established Supreme Court rule that says higher appellate authorities’ orders must be respected, even if the department plans to fight them more.
The fact that an appeal could be made against the Tribunal’s order does not bring back findings that have already been set aside. The decision of the Tribunal is final until a higher court changes it.
This notion is very important for making sure that taxes are collected fairly. Without it, taxpayers would be stuck in a never-ending cycle of provisional taxation, no matter how many times they win in appellate courts.
What This Means for Companies Doing Business in India
The Zscaler judgement has a lot of vital lessons to teach us in real life.
First, multinational groups shouldn’t merely accept bad Section 197 orders because they happened before. If earlier conclusions have been overturned, that fact has a lot of legal weight, even at the withholding stage.
Second, companies need to make sure that their paperwork for the current year is strong. The Court said that the Assessing Officer should have done a new examination, but it also said that PE determination is based on the facts of each case. Companies should have updated inter-company agreements, functional evaluations, and explanations of the Indian entity’s role ready to go.
Third, the ruling makes it clearer that marketing support and sales facilitation alone do not inherently make a DAPE. This depends on the facts, but the judgement fits with a growing corpus of case law that says there must be clear proof of authorisation to sign contracts or regularly perform the main role.
Why This Decision Is Part of a Bigger Trend
The Zscaler decision is not the first one of this kind. It fits with a larger trend in the Indian courts where they are pushing back against overly aggressive PE claims, especially in the post-Engineering Analysis world.
As software and digital companies move away from paying royalties, tax authorities have tried more and more to use PE theories to reclassify income as corporate earnings. But courts are demanding discipline, proof, and analysis that is relevant to each year instead of making assumptions.
This balance is very important for India’s investment climate. Long-term business planning is easier when taxes are predictable, but withholding taxes at random makes it harder to trade across borders.
In conclusion, remember that process is just as important as power.
The Zscaler case serves as a reminder that tax administration involves more than just collecting money; it also requires following the law, honouring appellate rulings, and using the correct test at the right time.
The ruling gives taxpayers hope that the help given by appellate courts is real, especially at early stages like withholding. For tax officials, it is a warning not to take shortcuts and a call to make choices stronger by looking at them carefully instead of making them again.
This method is good for everyone in the long run. When choices about withholding taxes are based on facts and good legal reasoning, there are fewer arguments, more people follow the rules, and people trust the system more.
That might be the most important thing to learn from the Zscaler case.
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