`dotnet tool restore` cannot find the local manifest file

Describe the bug

After upgrading dotnet to 7.0.9, dotnet tool restore cannot find the manifest file in .config/dotnet-tools.json

It returns:

Cannot find a manifest file.
For a list of locations searched, specify the "-d" option before the tool name.
No tools were restored.

Running dotnet new tool-manifest will reset the manifest file and after adding the tools it still do not pick those tools up.

Affected platforms

This only happens on Windows. MacOS seems to work. Have not tried linux.

To Reproduce

1. Run dotnet new tool-manifest
2. Add a tool. See example below. (running dotnet tool install Cake.Tool --version 3.1.0 will also fail with same error)
3. Run dotnet tool restore

.config/dotnet-tools.json

{
  "version": 1,
  "isRoot": true,
  "tools": {
    "cake.tool": {
      "version": "3.1.0",
      "commands": [
        "dotnet-cake"
      ]
    }
  }
}

Further technical details

dotnet --info

.NET SDK:
 Version:   7.0.306
 Commit:    f500069cb7

Runtime Environment:
 OS Name:     Windows
 OS Version:  10.0.22621
 OS Platform: Windows
 RID:         win10-x64
 Base Path:   C:\Program Files\dotnet\sdk\7.0.306\

Host:
  Version:      7.0.9
  Architecture: x64
  Commit:       8e9a17b221

.NET SDKs installed:
  5.0.405 [C:\Program Files\dotnet\sdk]
  7.0.103 [C:\Program Files\dotnet\sdk]
  7.0.304 [C:\Program Files\dotnet\sdk]
  7.0.306 [C:\Program Files\dotnet\sdk]

.NET runtimes installed:
  Microsoft.AspNetCore.App 3.1.22 [C:\Program Files\dotnet\shared\Microsoft.AspNetCore.App]
  Microsoft.AspNetCore.App 3.1.32 [C:\Program Files\dotnet\shared\Microsoft.AspNetCore.App]
  Microsoft.AspNetCore.App 5.0.14 [C:\Program Files\dotnet\shared\Microsoft.AspNetCore.App]
  Microsoft.AspNetCore.App 6.0.18 [C:\Program Files\dotnet\shared\Microsoft.AspNetCore.App]
  Microsoft.AspNetCore.App 7.0.7 [C:\Program Files\dotnet\shared\Microsoft.AspNetCore.App]
  Microsoft.AspNetCore.App 7.0.9 [C:\Program Files\dotnet\shared\Microsoft.AspNetCore.App]
  Microsoft.NETCore.App 3.1.22 [C:\Program Files\dotnet\shared\Microsoft.NETCore.App]
  Microsoft.NETCore.App 3.1.32 [C:\Program Files\dotnet\shared\Microsoft.NETCore.App]
  Microsoft.NETCore.App 5.0.14 [C:\Program Files\dotnet\shared\Microsoft.NETCore.App]
  Microsoft.NETCore.App 6.0.10 [C:\Program Files\dotnet\shared\Microsoft.NETCore.App]
  Microsoft.NETCore.App 6.0.11 [C:\Program Files\dotnet\shared\Microsoft.NETCore.App]
  Microsoft.NETCore.App 6.0.12 [C:\Program Files\dotnet\shared\Microsoft.NETCore.App]
  Microsoft.NETCore.App 6.0.13 [C:\Program Files\dotnet\shared\Microsoft.NETCore.App]
  Microsoft.NETCore.App 6.0.14 [C:\Program Files\dotnet\shared\Microsoft.NETCore.App]
  Microsoft.NETCore.App 6.0.15 [C:\Program Files\dotnet\shared\Microsoft.NETCore.App]
  Microsoft.NETCore.App 6.0.16 [C:\Program Files\dotnet\shared\Microsoft.NETCore.App]
  Microsoft.NETCore.App 6.0.18 [C:\Program Files\dotnet\shared\Microsoft.NETCore.App]
  Microsoft.NETCore.App 7.0.7 [C:\Program Files\dotnet\shared\Microsoft.NETCore.App]
  Microsoft.NETCore.App 7.0.9 [C:\Program Files\dotnet\shared\Microsoft.NETCore.App]
  Microsoft.WindowsDesktop.App 3.1.22 [C:\Program Files\dotnet\shared\Microsoft.WindowsDesktop.App]
  Microsoft.WindowsDesktop.App 3.1.32 [C:\Program Files\dotnet\shared\Microsoft.WindowsDesktop.App]
  Microsoft.WindowsDesktop.App 5.0.14 [C:\Program Files\dotnet\shared\Microsoft.WindowsDesktop.App]
  Microsoft.WindowsDesktop.App 6.0.18 [C:\Program Files\dotnet\shared\Microsoft.WindowsDesktop.App]
  Microsoft.WindowsDesktop.App 7.0.7 [C:\Program Files\dotnet\shared\Microsoft.WindowsDesktop.App]
  Microsoft.WindowsDesktop.App 7.0.9 [C:\Program Files\dotnet\shared\Microsoft.WindowsDesktop.App]

Other architectures found:
  x86   [C:\Program Files (x86)\dotnet]
    registered at [HKLM\SOFTWARE\dotnet\Setup\InstalledVersions\x86\InstallLocation]

Environment variables:
  Not set

global.json file:
  Not found

Learn more:
  https://aka.ms/dotnet/info

Download .NET:
  https://aka.ms/dotnet/download

[baronfel]

@JL03-Yue can you take a look at this? It might be related to your recent fix.

[KalleOlaviNiemitalo]

The breaking change document Tool manifests in root folder mentions that the original behaviour can be restored by setting the DOTNET_TOOLS_ALLOW_MANIFEST_IN_ROOT environment variable.