Ralf Brandstaetter, who took over from Diess as head of the core Volkswagen brand last year, will join the board and lead a new division entitled Volkswagen Passenger Cars from Jan. 1, the company said in a statement.
He will also take over Volkswagen's China business from Diess from Aug. 1. However, Diess will take on responsibility for the company's software unit Cariad, which bears a key function in the company's transformation efforts.
"I cannot complain about a lack of responsibilities - I continue to feel fully responsible for the company," Diess said.
Diess's future had been in doubt following clashes with Volkswagen's powerful labour unions, although sources told Reuters as early as November he was likely to stay on.
Preference shares in the company traded 1% lower, giving up some gains after being boosted by speculation about a possible listing of luxury division Porsche AG earlier this week.
Diess' management and communication style, warning of tens of thousands of possible job losses in coming years and frequently highlighting the threat of competition from Tesla, angered the carmaker's works council, prompting weeks of negotiations over his future at the firm.
At a news conference on Thursday, works council head Daniela Cavallo, who had lashed out at Diess for fuelling concerns among the carmaker's workforce, said she was happy with the outcome of negotiations.
"I have no interest for us to have these conflicts in public," Cavallo said. "The conclusions of this planning round are clear: we have a solid and robust plan we can all be proud of."
The company's supervisory board presented its annual update to the company's five-year rolling investment plan on Thursday, outlining investments of 159 billion euros ($180 billion) - up from 150 billion euros last year - including electrifying more of Volkswagen's sites across Europe.
Volkswagen Supervisory Board Chairman Hans Dieter Poetsch said the group was able to fully fund the programme, adding the group had some intelligent financing concepts up its sleeve, without being more specific.
Spending for electric vehicles will be raised to 52 billion euros, up around half compared with last year's blueprint, which Diess said was also a reflection of the changes Volkswagen is going through to overtake Tesla.
"We are becoming a battery manufacturer, a charging infrastructure manager, software is playing a more dominant role ... we are developing new business activities with an unbelievable dimension for us," he said.
Diess said Volkswagen expected to generate 20 billion euros of revenue by 2030 from its battery division alone, which is being readied for a partial sale or listing.
The reorganisation of the leadership team would see the Volkswagen Group delegating management of individual car brands to focus on these overarching business areas, Diess said.
The world's second-largest carmaker also confirmed it expects its operating margin to be at the upper end of its 6-7.5% target range for 2021.
($1 = 0.8836 euros)
(Reporting by Jan Schwartz, Victoria Waldersee, Christoph Steitz and Ilona Wissenbach; Editing by Miranda Murray, Mark Potter, Elaine Hardcastle)
By Jan Schwartz and Victoria Waldersee