Neely, Justice:
These cases were consolidated in this Court to determine whether certain lease and lease/purchase agreements should be considered as sales or rentals for the purposes of the State’s Business and Occupation Tax. The transactions in question involve heavy machinery used in construction and surface mining. Both appellees engage in the sales, service and rental of such machinery. Many of the customers of appellees cannot afford to buy new equipment when needed, either because of the large down payment required, or because incurring debts of that magnitude would make pre-qualification and bonding for state road projects more difficult and expensive. To facilitate sales in these situations the appellee companies follow the trade practice of allowing their customers to lease the equipment initially. In general, the customer is required to keep the equipment and pay rent for at least six months. However, at any time during the six month period the customer may buy the equipment outright and apply to the down payment all of the rental payments already made.
If the customer does not buy the equipment during the first six months and wants to keep it longer, he may continue to lease it from month to month while retaining an option to buy. Both appellees transfer title to customers when the sum of monthly payments equals the initial purchase price of the equipment plus a finance charge. Such sales are called lease payouts. In effect, then, there are two methods by which equipment can be purchased: the exercise of the option to buy and the lease payout. Most of
these agreements are oral, but at times they are written. While the written agreements specifically disclaim any purchase options, both appellees demonstrate that this disclaimer is routinely waived orally.
During the contract period the appellees retain title to the equipment but they require their customers to insure it. The customers pay all personal property taxes for the equipment while it is in their possession. Appellees do not take depreciation on the equipment nor do they take
investment tax credits, and their customers treat their payments as expenditures for capital, not rent payments, for federal tax purposes. The Internal Revenue Service characterizes these lease agreements as sales because the purchase option is exercisable within a period clearly less than the expected life of the equipment and the rental payments cover a substantial portion of the costs of the equipment,
see I.R.C.
§ 162(a) (1976); Rev. Rul. 540, 1955-2 C.B. 39. The conclusion that the parties intend sales to transpire is supported by the fact that 95% of the equipment leased by appellee Wright-Thomas eventually is sold to lessees and 70% of appellee West Virginia Tractor’s dollar sales volume is derived from what were initially lease agreements.
If these agreements are sales, they enjoy a lower tax rate under
W. Va. Code,
11-13-2(c) [1971] than if they are leases
of equipment,
Code,
11-13-2(i) [1971]. Taxpayers prevailed in their appeal to the Circuit Court of Kanawha County from a ruling by the State Tax Commissioner which held these transactions to be leases. The circuit court concluded, however, that the substance and not the form of a transaction is decisive for tax purposes and it held that the lease/purchase arrangements should be taxed at the lower sales rate. The Tax Commissioner now appeals from that decision. We disagree with the circuit court’s ruling and therefore we reverse.
I
Appellees claim that for all practical purposes they consider these agreements sales, not the furnishing of property for hire. They conclude, therefore, that their income from the lease transactions should be taxed at the rate for wholesale sales,
Code,
11-13-2(c) [1971] because
in substance
they
are
sales, or alternatively, because they are necessary to and thus included in the business of wholesale sales. Appellant Tax Commissioner claims, however, that regardless of the parties’ intentions, the transactions are leases and should be taxed at the higher rate set for the leasing of property,
Code
11-13-2(i) [1971]. While the leases may be convenient for appellees, they are not part of the business of selling at wholesale.
Appellees’ argument is essentially that their tax should be assessed on the basis of the substance of their transactions, not the form. However, tax law is a creature of statute and it is the statute which determines the issue. It is well settled in this State that when a tax statute is clear and free from ambiguity, it will be applied and not construed.
State ex rel. Hardesty v. Aracoma-Chief Logan No. 4523, V.F.W.,
147 W. Va. 645, 129 S.E.2d 921, 924 (1963);
J. D. Moore, Inc. v. Hardesty,
147 W. Va. 611,129 S.E.2d 722, 724-25 (1963). In
Code,
11-13-1 [1971], sales are defined to include “any transfer of the ownership of or title to property.” It is clear that appellees are not engaged in sales because the transactions by their own terms do not involve the transfer of ownership or title in the property. Unless the lessee chooses to buy the equipment at the end of the
rental period he has received nothing for his money other than the use of the equipment during the rental period.
Moreover, the written agreements in the record all call themselves leases and disclaim any options to buy.
In other cases we have noted that the actual rights and duties owed to third parties and the rest of the world which are established by the terms of taxpayers’ transactions are controlling for purposes of the Business and Occupation Tax,
see, e.g., Frazee Lumber Co. v. Haden,
156 W.Va. 844, 197 S.E.2d 634 (1973) (since contract between taxpayer and third party clearly identifies taxpayer as timber producer, he is liable as such under
Code,
11-13-2(a));
State ex rel. Hardesty v. Aracoma-Chief Logan No. 4523, V.F.W.,
147 W.Va. 645, 129 S.E.2d 921 (1961) (when fraternal lodge holds itself out to public as caterer for profit, in competition with commercial restaurants and caterers, income from such catering is not exempt from tax on sales,
Code,
11-13-2(c), as income of charitable organization,
Code,
11-13-3). In the .cases before us, the rights and duties of appellees are established in the agreements they chose to call leases, not sales. The terms of the agreements provide for the customers’ use of the equipment, not ownership. The agreements do not provide the customers with any interest in the property.
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Neely, Justice:
These cases were consolidated in this Court to determine whether certain lease and lease/purchase agreements should be considered as sales or rentals for the purposes of the State’s Business and Occupation Tax. The transactions in question involve heavy machinery used in construction and surface mining. Both appellees engage in the sales, service and rental of such machinery. Many of the customers of appellees cannot afford to buy new equipment when needed, either because of the large down payment required, or because incurring debts of that magnitude would make pre-qualification and bonding for state road projects more difficult and expensive. To facilitate sales in these situations the appellee companies follow the trade practice of allowing their customers to lease the equipment initially. In general, the customer is required to keep the equipment and pay rent for at least six months. However, at any time during the six month period the customer may buy the equipment outright and apply to the down payment all of the rental payments already made.
If the customer does not buy the equipment during the first six months and wants to keep it longer, he may continue to lease it from month to month while retaining an option to buy. Both appellees transfer title to customers when the sum of monthly payments equals the initial purchase price of the equipment plus a finance charge. Such sales are called lease payouts. In effect, then, there are two methods by which equipment can be purchased: the exercise of the option to buy and the lease payout. Most of
these agreements are oral, but at times they are written. While the written agreements specifically disclaim any purchase options, both appellees demonstrate that this disclaimer is routinely waived orally.
During the contract period the appellees retain title to the equipment but they require their customers to insure it. The customers pay all personal property taxes for the equipment while it is in their possession. Appellees do not take depreciation on the equipment nor do they take
investment tax credits, and their customers treat their payments as expenditures for capital, not rent payments, for federal tax purposes. The Internal Revenue Service characterizes these lease agreements as sales because the purchase option is exercisable within a period clearly less than the expected life of the equipment and the rental payments cover a substantial portion of the costs of the equipment,
see I.R.C.
§ 162(a) (1976); Rev. Rul. 540, 1955-2 C.B. 39. The conclusion that the parties intend sales to transpire is supported by the fact that 95% of the equipment leased by appellee Wright-Thomas eventually is sold to lessees and 70% of appellee West Virginia Tractor’s dollar sales volume is derived from what were initially lease agreements.
If these agreements are sales, they enjoy a lower tax rate under
W. Va. Code,
11-13-2(c) [1971] than if they are leases
of equipment,
Code,
11-13-2(i) [1971]. Taxpayers prevailed in their appeal to the Circuit Court of Kanawha County from a ruling by the State Tax Commissioner which held these transactions to be leases. The circuit court concluded, however, that the substance and not the form of a transaction is decisive for tax purposes and it held that the lease/purchase arrangements should be taxed at the lower sales rate. The Tax Commissioner now appeals from that decision. We disagree with the circuit court’s ruling and therefore we reverse.
I
Appellees claim that for all practical purposes they consider these agreements sales, not the furnishing of property for hire. They conclude, therefore, that their income from the lease transactions should be taxed at the rate for wholesale sales,
Code,
11-13-2(c) [1971] because
in substance
they
are
sales, or alternatively, because they are necessary to and thus included in the business of wholesale sales. Appellant Tax Commissioner claims, however, that regardless of the parties’ intentions, the transactions are leases and should be taxed at the higher rate set for the leasing of property,
Code
11-13-2(i) [1971]. While the leases may be convenient for appellees, they are not part of the business of selling at wholesale.
Appellees’ argument is essentially that their tax should be assessed on the basis of the substance of their transactions, not the form. However, tax law is a creature of statute and it is the statute which determines the issue. It is well settled in this State that when a tax statute is clear and free from ambiguity, it will be applied and not construed.
State ex rel. Hardesty v. Aracoma-Chief Logan No. 4523, V.F.W.,
147 W. Va. 645, 129 S.E.2d 921, 924 (1963);
J. D. Moore, Inc. v. Hardesty,
147 W. Va. 611,129 S.E.2d 722, 724-25 (1963). In
Code,
11-13-1 [1971], sales are defined to include “any transfer of the ownership of or title to property.” It is clear that appellees are not engaged in sales because the transactions by their own terms do not involve the transfer of ownership or title in the property. Unless the lessee chooses to buy the equipment at the end of the
rental period he has received nothing for his money other than the use of the equipment during the rental period.
Moreover, the written agreements in the record all call themselves leases and disclaim any options to buy.
In other cases we have noted that the actual rights and duties owed to third parties and the rest of the world which are established by the terms of taxpayers’ transactions are controlling for purposes of the Business and Occupation Tax,
see, e.g., Frazee Lumber Co. v. Haden,
156 W.Va. 844, 197 S.E.2d 634 (1973) (since contract between taxpayer and third party clearly identifies taxpayer as timber producer, he is liable as such under
Code,
11-13-2(a));
State ex rel. Hardesty v. Aracoma-Chief Logan No. 4523, V.F.W.,
147 W.Va. 645, 129 S.E.2d 921 (1961) (when fraternal lodge holds itself out to public as caterer for profit, in competition with commercial restaurants and caterers, income from such catering is not exempt from tax on sales,
Code,
11-13-2(c), as income of charitable organization,
Code,
11-13-3). In the .cases before us, the rights and duties of appellees are established in the agreements they chose to call leases, not sales. The terms of the agreements provide for the customers’ use of the equipment, not ownership. The agreements do not provide the customers with any interest in the property. Appellees cannot complain now that the State Tax Commissioner takes them seriously.
It does not matter for State Business and Occupation Tax purposes that the Internal Revenue Service may treat these agreements as sales, not leases. The I.R.S. would tax appellees at the same rate whether their income were from sales or leases. Their concern is with whether appellees’
customers may deduct their expenditures as rent and the I.R.S. is specifically required by statute to go behind the form of agreements to look at their substance for that purpose. In this regard the structure of the federal tax law differs explicitly from the State law since in the State system there is no express or implied authority to look at substance. Thus I.R.C. § 162 (a) (1976) provides that:
There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including -
(3) rentals or other payments required to be made as a condition to the continued use or possession, for purposes of the trade or business, of property to which the taxpayer has not taken or is not taking title or in which he has no equity.
For the I.R.S. to determine whether appellees’ customers may take this deduction, they must determine that those customers neither have nor are taking title nor
have an equity interest in the equipment.
This requires an evaluation of the substance of the agreements and the intentions of the parties. Since the avowed purpose of the objective trade practice is to provide appellees’ customers with equity in the equipment to facilitate purchases by them, this is an easy case for the United States to deny rental deductions. It is clear from the terms of these agreements that the lessee/purchaser is paying rent at a rate which affords him an opportunity to achieve an equity position and thus the rental payments are in excess of “ordinary and necessary” payments for the mere use of equipment.
However, the State Business and Occupation Tax does differentiate between rental and sales income and it has no similar implied mandate to go beyond the form of the transaction to determine its underlying characteristics. Since
Code
11-13-2(c) hinges on whether ownership or title (not equity) has passed (as opposed to could potentially pass in the future), this is an equally easy case for the State of West Virginia to impose the tax at the rental, not sales,
rate. Unless a separate sale takes place, the lessee does not gain title or ownership.
II
It is irrelevant that a large number of the lease agreements result in sales. Such sales are subsequent to the leases, not consequences of them. Also, a portion of them never result in sales, despite the parties’ intentions at the outset. Apparently the business of leasing machinery is neither a necessary nor a sufficient precondition to the sale of such equipment and so is not an incident of the business of wholesale sales.
Cf. Appalachian Elec. Power Co. v. Koontz,
138 W.Va. 84, 76 S.E.2d 863 (1953) (income derived from late payment surcharges is incidental to business as public utility so taxable under
Code,
11-13-2(d), not at miscellaneous service rate,
Code,
11-13-2(h)). Leasing the equipment is not the equivalent of use by the appellees nor is it done for demonstration purposes. This contrasts with
Illinois Road Equip. Co. v. Dep’t of Revenue,
32 Ill. 2d 576, 207 N.E.2d 425 (1965), relied upon by appellees (similar transaction held to fall under exceptions to State use tax as either interim use or use for demonstration by retailer).
We cannot conclude, therefore, that appellees’ rental businesses are part of their wholesale sales businesses. Rather, leasing constitutes a separate component of their overall business and should be taxed separately, as established by/.
D. Moore, Inc. v. Hardesty,
147 W. Va. 611, 129 S.E.2d 72 (1963). By the same token, the principles of/.
D. Moore
dictate that once the lease ends and a sale is consummated, the income from the sale should be taxed at the wholesale sales rate. Inasmuch as there are two distinct transactions, they constitute different components of appellees’ businesses and are taxable separately. Thus once a sale transpires through exercise of the purchase option, further payments under the agreement should be taxed as sales under
Code,
ll-13-2(c) (1971).
We recognize that there are sound business reasons for appellees to want to structure their transactions in the way they have. We noted earlier that their customers find leasing makes bonding and pre-qualification requirements
cheaper and simpler for state road projects. Similarly, appellees may benefit from leasing rather than financing sales of the equipment should their customers go into bankruptcy. Appellees would be stayed from proceedings to recover the equipment if ownership had passed to the customer under a sale but not if possession passed under a lease,
see
11 U.S.C. § 362 (a) (1979 Supplement).
Accordingly, the judgment of the Circuit Court of Kanawha County is reversed and the case is remanded for further proceedings consistent with this opinion.
Reversed and remanded.