Shade needles of hybrid larch (Larix decidua × leptolepis) had the same rates of photosynthesis as sun needles per dry weight and nitrogen, and a similar leaf conductance under conditions of light saturation at ambient CO2 (Amax). However, on an area basis, Amax and specific leaf weight were lower in shade than in sun needles. Stomata of sun needles limited CO2 uptake at light saturation by about 20%, but under natural conditions of light in the shade crown, shade needles operated in a range of saturating internal CO2 without stomatal limitation of CO2 uptake. In both needle types, stomata responded similarly to changes in light, but shade needles were more sensitive to changes in vapor pressure deficit than sun needles. Despite a high photosynthetic capacity, the ambient light conditions reduced the mean daily (in summer) and annual carbon gain of shade needles to less than 50% of that in sun needles. In sun needles, the transpiration per carbon gain was about 220 mol mol−1 on an annual basis. The carbon budget of branches was determined from the photosynthetic rate, the needle biomass and respiration, the latter of which was (per growth and on a carbon basis) 1.6 mol mol−1 year−1 in branch and stem wood. In shade branches carbon gains exceeded carbon costs (growth + respiration) by only a factor of 1.6 compared with 3.5 in sun branches. The carbon balance of sun branches was 5 times higher per needle biomass of a branch or 9 times higher on a branch length basis than shade branches. The shade foliage (including the shaded near-stem sun foliage) only contributed approximately 23% to the total annual carbon gain of the tree.