Doctor Parnassus' (Plummer) theatre troupe, which includes sleight of hand expert Anton (Garfield), confidant Percy (Troyer), and Parnassus' daughter Valentina (Cole), performs outside a London pub. A drunk (Richard Riddell) barges onstage and crashes through a stage mirror, where his face changes (Bruce Crawford), and he enters a journey of imagination that culminates in a choice between a torturous-looking twelve-step program and going to a pub. He enters the pub, but it explodes; in the real world, Parnassus says he has lost another one to Mr. Nick (Waits).
Mr. Nick reminds Parnassus that in three days Valentina turns 16, and her soul will be his. Drinking and playing tarot, Parnassus tells Valentina that, centuries earlier, he ran a monastery where monks perpetually recited stories to sustain the world. Mr. Nick challenged their beliefs by sealing their mouths. The world survived, but Parnassus claimed it was because of stories told elsewhere. Mr. Nick had bet Parnassus who could win more souls. Parnassus won twelve souls before Mr. Nick, and gained immortality.
As the troupe crosses a bridge, Anton spies someone hanging beneath it. They rescue the man (Ledger), who spits out a golden pipe when revived. Claiming to have amnesia, the man joins the troupe as a barker. Parnassus becomes despondent over the impending loss of his daughter. Mr. Nick visits Parnassus, revealing the hanging man is a disgraced philanthropist named "Tony". He offers Parnassus a wager: Valentina can stay with whoever wins five souls first.
Tony convinces the troupe to remodel the show as more attractive to contemporary Londoners. In an upscale mall, Tony lures a woman (Maggie Steed) into the mirror and follows her, where they enter a pastel-coloured dream-world of giant high-heel shoes, bejewelled eggs, and floating lily pads, representing the woman's imagination. The woman's imagination also changes Tony's face (Depp); upon discovering this, he dances elegantly with her, and they spy a motel run by Mr. Nick. Tony convinces the woman to take a gondola toward a pyramid alone, winning a soul for Parnassus. Tony then falls back out of the Imaginarium, changing his face back to normal; the woman exits shortly after and writes a blank check. Three other women clamour for a turn. Each emerges elated; Parnassus wins three more souls.
Four Russian gangsters chase Tony, who owes them money, into the Imaginarium. As they threaten Tony, who has transformed into his vision of a successful man (Law), Parnassus tempts them with a police recruitment song, promising they will enjoy being cops who can legally brutalise people. Mr. Nick lures them to a woman that takes the form of their mother with a giant babushka. It explodes; the score is four souls apiece.
Parnassus reveals to Valentina that in an hour she will belong to Mr. Nick. He finally explains he made a new pact with Mr. Nick to be youthful again, so to win the heart of a woman he loved. In exchange, any child he fathered would become Mr. Nick's property at age 16. Valentina attempts to run away, but Tony enters the Imaginarium to give his soul to Parnassus; in exchange, Parnassus must teach him the trance which powers the dream-world. Valentina returns as he tries to enter the mirror, but Anton blocks them, having discovered that Tony is a fraudulent charity scammer.
Anton struggles with Tony; in the scuffle, first Valentina, then Tony, enter the mirror. Influenced by Valentina's desires, Tony's face changes again (Farrell), and they float along a beautiful river in a gondola. Shortly after an impoverished child disrupts their boat trip, Tony is suddenly now a philanthropist, speaking at a fundraiser. Anton appears as an outspoken child and exposes Tony as a fraud. A mob pursues Tony as the landscape disintegrates. Anton falls into a void, and Tony flees into a desert.
Distraught over her father's bargain, Valentina gives her soul to Mr. Nick. Disillusioned at his easy victory, Mr. Nick offers to trade Valentina for Tony. Chased by the mob, Tony flees to a gallows, but Parnassus confronts him, holding Tony's pipe and a copy. Parnassus challenges Tony to choose which pipe is genuine. He chooses wrongly, inserts the copy in his windpipe, and does not survive being hanged. Mr. Nick keeps his word and Valentina is freed, but Parnassus is abandoned in the Imaginarium.
Parnassus emerges from the Imaginarium years later, and finds Valentina is married to Anton and they have a daughter. He watches them from outside a restaurant window, but when tempted to join them, he is stopped by Percy. Teaming up once more, Parnassus and Percy sell toy theatre replicas of the Imaginarium on a street corner. Mr. Nick invites Parnassus over to him, but Percy successfully puts an end to the temptation.