diff --git a/src/ng/compile.js b/src/ng/compile.js
index 8b6491091de7..52592d3792b3 100644
--- a/src/ng/compile.js
+++ b/src/ng/compile.js
@@ -1292,6 +1292,14 @@ function $CompileProvider($provide, $$sanitizeUriProvider) {
       return function publicLinkFn(scope, cloneConnectFn, options) {
         assertArg(scope, 'scope');
 
+        if (previousCompileContext && previousCompileContext.needsNewScope) {
+          // A parent directive did a replace and a directive on this element asked
+          // for transclusion, which caused us to lose a layer of element on which
+          // we could hold the new transclusion scope, so we will create it manually
+          // here.
+          scope = scope.$parent.$new();
+        }
+
         options = options || {};
         var parentBoundTranscludeFn = options.parentBoundTranscludeFn,
           transcludeControllers = options.transcludeControllers,
@@ -1875,7 +1883,8 @@ function $CompileProvider($provide, $$sanitizeUriProvider) {
             }
 
             $compileNode.empty(); // clear contents
-            childTranscludeFn = compilationGenerator(mightHaveMultipleTransclusionError, $template, transcludeFn);
+            childTranscludeFn = compilationGenerator(mightHaveMultipleTransclusionError, $template, transcludeFn, undefined,
+                undefined, { needsNewScope: directive.$$isolateScope || directive.$$newScope});
             childTranscludeFn.$$slots = slots;
           }
         }
@@ -1918,8 +1927,11 @@ function $CompileProvider($provide, $$sanitizeUriProvider) {
             var templateDirectives = collectDirectives(compileNode, [], newTemplateAttrs);
             var unprocessedDirectives = directives.splice(i + 1, directives.length - (i + 1));
 
-            if (newIsolateScopeDirective) {
-              markDirectivesAsIsolate(templateDirectives);
+            if (newIsolateScopeDirective || newScopeDirective) {
+              // The original directive caused the current element to be replaced but this element
+              // also needs to have a new scope, so we need to tell the template directives
+              // that they would need to get their scope from further up, if they require transclusion
+              markDirectiveScope(templateDirectives, newIsolateScopeDirective, newScopeDirective);
             }
             directives = directives.concat(templateDirectives).concat(unprocessedDirectives);
             mergeTemplateAttributes(templateAttrs, newTemplateAttrs);
@@ -2214,10 +2226,15 @@ function $CompileProvider($provide, $$sanitizeUriProvider) {
       }
     }
 
-    function markDirectivesAsIsolate(directives) {
-      // mark all directives as needing isolate scope.
+    // Depending upon the context in which a directive finds itself it might need to have a new isolated
+    // or child scope created. For instance:
+    // * if the directive has been pulled into a template because another directive with a higher priority
+    // asked for element transclusion
+    // * if the directive itself asks for transclusion but it is at the root of a template and the original
+    // element was replaced. See https://github.com/angular/angular.js/issues/12936
+    function markDirectiveScope(directives, isolateScope, newScope) {
       for (var j = 0, jj = directives.length; j < jj; j++) {
-        directives[j] = inherit(directives[j], {$$isolateScope: true});
+        directives[j] = inherit(directives[j], {$$isolateScope: isolateScope, $$newScope: newScope});
       }
     }
 
@@ -2364,7 +2381,9 @@ function $CompileProvider($provide, $$sanitizeUriProvider) {
             var templateDirectives = collectDirectives(compileNode, [], tempTemplateAttrs);
 
             if (isObject(origAsyncDirective.scope)) {
-              markDirectivesAsIsolate(templateDirectives);
+              // the original directive that caused the template to be loaded async required
+              // an isolate scope
+              markDirectiveScope(templateDirectives, true);
             }
             directives = templateDirectives.concat(directives);
             mergeTemplateAttributes(tAttrs, tempTemplateAttrs);
diff --git a/test/ng/compileSpec.js b/test/ng/compileSpec.js
index da016f74c5ac..a89fa6dd222c 100755
--- a/test/ng/compileSpec.js
+++ b/test/ng/compileSpec.js
@@ -5636,6 +5636,62 @@ describe('$compile', function() {
         });
       });
 
+      //see issue https://github.com/angular/angular.js/issues/12936
+      it('should use the proper scope when being the root element of a replaced directive', function() {
+        module(function() {
+          directive('isolate', valueFn({
+            scope: {},
+            replace: true,
+            template: '<div trans>{{x}}</div>',
+            link: function(scope, element, attr, ctrl) {
+              scope.x = 'iso';
+            }
+          }));
+          directive('trans', valueFn({
+            transclude: 'content',
+            link: function(scope, element, attr, ctrl, $transclude) {
+              $transclude(function(clone) {
+                element.append(clone);
+              });
+            }
+          }));
+        });
+        inject(function($rootScope, $compile) {
+          element = $compile('<isolate></isolate>')($rootScope);
+          $rootScope.x = 'root';
+          $rootScope.$apply();
+          expect(element.text()).toEqual('iso');
+        });
+      });
+
+
+      //see issue https://github.com/angular/angular.js/issues/12936
+      it('should use the proper scope when being the root element of a replaced directive with child scope', function() {
+        module(function() {
+          directive('child', valueFn({
+            scope: true,
+            replace: true,
+            template: '<div trans>{{x}}</div>',
+            link: function(scope, element, attr, ctrl) {
+              scope.x = 'child';
+            }
+          }));
+          directive('trans', valueFn({
+            transclude: 'content',
+            link: function(scope, element, attr, ctrl, $transclude) {
+              $transclude(function(clone) {
+                element.append(clone);
+              });
+            }
+          }));
+        });
+        inject(function($rootScope, $compile) {
+          element = $compile('<child></child>')($rootScope);
+          $rootScope.x = 'root';
+          $rootScope.$apply();
+          expect(element.text()).toEqual('child');
+        });
+      });
 
 
       it('should not leak if two "element" transclusions are on the same element (with debug info)', function() {