Forest ecosystems across the globe show an increase in ecosystem carbon uptake efficiency under conditions with high fraction of diffuse radiation. Here, we combine eddy covariance flux measurements at a deciduous temperate forest in central Germany with canopy-scale modeling using the biophysical multilayer model CANVEG to investigate the impact of diffuse radiation on various canopy gas exchange processes and to elucidate the underlying mechanisms. Increasing diffuse radiation enhances canopy photosynthesis by redistributing the solar radiation load from light saturated sunlit leaves to nonsaturated shade leaves. Interactions with atmospheric vapor pressure deficit and reduced leaf respiration are only of minor importance to canopy photosynthesis. The response strength of carbon uptake to diffuse radiation depends on canopy characteristics such as leaf area index and leaf optical properties. Our model computations shows that both canopy photosynthesis and transpiration increase initially with diffuse fraction, but decrease after an optimum at a diffuse fraction of 0.45 due to reduction in global radiation. The initial increase in canopy photosynthesis exceeds the increase in transpiration, leading to a rise in water-use-efficiency. Our model predicts an increase in carbon isotope discrimination with water-use-efficiency resulting from differences in the leaf-to-air vapor pressure gradient and atmospheric vapor pressure deficit. This finding is in contrast to those predicted with simple big-leaf models that do not explicitly calculate leaf energy balance. At an annual scale, we estimate a decrease in annual carbon uptake for a potential increase in diffuse fraction, since diffuse fraction was beyond the optimum for 61% of the data.