How to create an Application User in Dynamics 365 CE

Go to https://portal.azure.com/ and search for "App Registrations" :

On the App registrations blade, click on "New Registration" :

On the registration page, fill the Name and click on "Register" :

After successful creation, copy the "Application (client ID)" GUID and click on "Add a certificate or secret" :

On the Certificates & Secrets blade, go to the " Client Secrets" tab and click on "New Client Secret" :

Fill in the Description field and choose an expiry time :

After pressing "Add", copy the client secret Value field :

Go to the "API Permissions" blade and click on "Add a permission" 

Select the Dynamics CRM API and check the "user_impersonation" permission. Click on "Add Permissions" :

Now that we have an application user created, we need to give it permissions on the Dataverse instance : 

Go to https://admin.powerplatform.microsoft.com/ , Environments and open the environment where you want to give permissions to the App User and click on "Settings" 

On the Settings page, expand "Users + permissions" and click on "Application users"

On the "Application Users" page, click on "New App User", on the popup click "Add an app" and search for your just created App User :

Select it and click "Add", select the Business Unit and choose one or more security roles and click "Create" :

If the user is successfully created a message like the below should appear and the App User should be visible on the grid :

If using XRM Tooling, you can connect with the App User using a connection string like the one below :

<add name="MyCDSServer" 
  connectionString="
  AuthType=ClientSecret;
  url=https://contosotest.crm.dynamics.com;
  ClientId={AppId};
  ClientSecret={ClientSecret}"
  />