Legal rights and business interests: potential pitfalls and planning considerations

Scotland’s succession law is unique within the UK. Unlike England and Wales, where testamentary freedom is broad, Scots law imposes forced heirship rules through the concept of legal rights.

These rights apply when someone dies domiciled in Scotland, whether they leave a will (testate) or not (intestate). Because legal rights apply automatically on death, it is almost impossible to avoid them albeit there are limited opportunities to undertake lifetime planning to mitigate them. For business owners in particular, legal rights require careful consideration and planning, with a view to avoiding commercial disruption and unintended and undesirable tax implications on death.

How are business assets treated for legal rights?

Legal rights entitle the surviving spouse/civil partner (collectively referred to as the “spouse”) and children to either one half or one third of the deceased’s net worldwide moveable estate. Crucially for business owners, moveable estate would include shares in a company. It may also include the deceased’s interest in a partnership, including any land and buildings owned by the partnership under section 22 of the Partnership Act 1890.

Legal rights entitle the spouse/children to a cash sum as opposed to a specific asset. Interest (at an undetermined rate) is payable on legal rights from the date of death to the date of payment.

How are business assets treated for legal rights?

Potential pitfalls

Conflict with wills: a carefully drafted will may be undermined if spouses/children claim legal rights. This could result in the intended beneficiaries receiving considerably less than expected, or potentially nothing at all. This could be particularly significant where business assets are concerned and the continuity of business operations is impacted.
Settlement of legal rights: for many business owners, their interest in a business will constitute their largest moveable asset and difficulties can arise if cash is required to pay legal rights. The company may have to pay a dividend which could create undesirable income tax implications. In the worst case, if the other assets in the estate are insufficient to pay the legal rights, the business may need to be sold. This is a very real consideration for those with an interest in a farming partnership and this fragmentation could have disastrous consequences for the long-term future of that farming business. Complexities and delays can also arise if the moveable estate includes foreign assets.
IHT and legal rights: if a child claims legal rights, this could create an immediate IHT liability for the deceased’s estate that might otherwise be avoided if planning had been undertaken. The correlation between legal rights and the IHT treatment of business assets also requires careful consideration. If adequate advice is not taken during lifetime and appropriate provisions are not included in a will, this could increase the IHT liability of the estate considerably. Consideration should be given in particular to section 39A of the Inheritance Tax Act 1984. A deed of variation might provide a more tax efficient solution but it will not be possible or appropriate in every case.
Valuation of business assets: the valuation of business assets for legal rights purposes can often create uncertainty given the differing valuation methodologies adopted, particularly for partnerships where assets may be owned by used, but not owned, by the business. This can increase the estate administration and associated costs.

Planning considerations

For those with business interests where legal rights are an actual or potential consideration, the following considerations might be applicable:

Draft a will: while legal rights cannot be excluded, a well drafted will provides clarity and can balance competing interests. It does not need to be complex but it should take account of a potential legal rights claim. Failure to provide any or adequate legal advice on legal rights during the deceased’s lifetime, particularly where business assets are concerned, could potentially expose the lifetime advisor to a professional negligence claim following the deceased’s death.
Draft a partnership agreement: the benefits of having a written partnership agreement are multifold. It can provide certainty in relation to the identity of partnership assets. It should also be possible to exclude land and buildings owned by the partnership from a legal rights claim within a partnership agreement. A partnership agreement could also provide a clear valuation methodology for legal rights (and other) purposes.
Lifetime gifting: assets gifted during lifetime would reduce the moveable estate subject to legal rights. In some instances, assets may be gifted in exchange for the recipient signing a formal discharge of their legal rights. Provided that the recipient has been advised to obtain independent legal advice, this is a legitimate form of planning but it is important to consider the IHT implications if the donor dies within 7 years of the gift.
Trusts: gifting assets to a trust during lifetime can mitigate a legal rights claim as assets held in trust should not form part of the legal rights pot (unless the settlor retained a benefit in the trust assets). Trusts may also be appropriate if there are young beneficiaries. However, the immediate and on-going tax implications and compliance obligations (and associated costs) should be considered carefully.
Insurance: for business owners in particular, life insurance may be appropriate to provide liquidity to meet an anticipated legal rights claims without disrupting business assets. The policy should be written in trust so that it is not subsequently subject to IHT at 40%.
Communication: Transparency and open discussions during lifetime about intentions on death can often reduce conflict after death, resulting in smoother (and less costly) estate administration. You might consider leaving a separate letter of wishes to sit alongside your will to provide more context to your family regarding your will. While legal rights are designed to protect families, they can can complicate estate planning—particularly for those with complex assets or blended families where professional advice at an early stage is essential. By understanding legal rights and planning ahead, individuals can make informed decisions with a view to reducing conflict, preserving business assets, mitigating tax and ensuring that their estate passes in line with their wishes.