diff --git a/app/finders/labels_finder.rb b/app/finders/labels_finder.rb
index f013e177c5ba3c4aac73dce919ec38c05cbd9cc1..5c9fce211ecb4cba776919d8b50121466fe3d198 100644
--- a/app/finders/labels_finder.rb
+++ b/app/finders/labels_finder.rb
@@ -39,7 +39,7 @@ class LabelsFinder < UnionFinder
         end
       end
     elsif only_group_labels?
-      label_ids << Label.where(group_id: group.id)
+      label_ids << Label.where(group_id: group_ids)
     else
       label_ids << Label.where(group_id: projects.group_ids)
       label_ids << Label.where(project_id: projects.select(:id))
@@ -59,10 +59,11 @@ class LabelsFinder < UnionFinder
     items.where(title: title)
   end
 
-  def group
-    strong_memoize(:group) do
+  def group_ids
+    strong_memoize(:group_ids) do
       group = Group.find(params[:group_id])
-      authorized_to_read_labels?(group) && group
+      groups = params[:include_ancestor_groups].present? ? group.self_and_ancestors : [group]
+      groups_user_can_read_labels(groups).map(&:id)
     end
   end
 
@@ -120,4 +121,10 @@ class LabelsFinder < UnionFinder
 
     Ability.allowed?(current_user, :read_label, label_parent)
   end
+
+  def groups_user_can_read_labels(groups)
+    DeclarativePolicy.user_scope do
+      groups.select { |group| authorized_to_read_labels?(group) }
+    end
+  end
 end
diff --git a/app/services/issuable_base_service.rb b/app/services/issuable_base_service.rb
index 66a9b1f82e0e9d8fbb087d5eb523b3c311435c0f..e87fd49d1935481ce01921ff2fdd2bce2010cc17 100644
--- a/app/services/issuable_base_service.rb
+++ b/app/services/issuable_base_service.rb
@@ -77,8 +77,12 @@ class IssuableBaseService < BaseService
     return unless labels
 
     params[:label_ids] = labels.split(",").map do |label_name|
-      service = Labels::FindOrCreateService.new(current_user, project, title: label_name.strip)
-      label   = service.execute
+      label = Labels::FindOrCreateService.new(
+        current_user,
+        parent,
+        title: label_name.strip,
+        available_labels: available_labels
+      ).execute
 
       label.try(:id)
     end.compact
@@ -102,7 +106,7 @@ class IssuableBaseService < BaseService
   end
 
   def available_labels
-    LabelsFinder.new(current_user, project_id: @project.id).execute
+    @available_labels ||= LabelsFinder.new(current_user, project_id: @project.id).execute
   end
 
   def merge_quick_actions_into_params!(issuable)
@@ -303,4 +307,8 @@ class IssuableBaseService < BaseService
   def update_project_counter_caches?(issuable)
     issuable.state_changed?
   end
+
+  def parent
+    project
+  end
 end
diff --git a/app/services/labels/find_or_create_service.rb b/app/services/labels/find_or_create_service.rb
index 940c8b333d3b045b23649c5f2e9131d19c85414b..079f611b3f3d76f1b758c85eb89665205b17a5df 100644
--- a/app/services/labels/find_or_create_service.rb
+++ b/app/services/labels/find_or_create_service.rb
@@ -1,8 +1,9 @@
 module Labels
   class FindOrCreateService
-    def initialize(current_user, project, params = {})
+    def initialize(current_user, parent, params = {})
       @current_user = current_user
-      @project = project
+      @parent = parent
+      @available_labels = params.delete(:available_labels)
       @params = params.dup.with_indifferent_access
     end
 
@@ -13,12 +14,13 @@ module Labels
 
     private
 
-    attr_reader :current_user, :project, :params, :skip_authorization
+    attr_reader :current_user, :parent, :params, :skip_authorization
 
     def available_labels
       @available_labels ||= LabelsFinder.new(
         current_user,
-        project_id: project.id
+        "#{parent_type}_id".to_sym => parent.id,
+        only_group_labels: parent_is_group?
       ).execute(skip_authorization: skip_authorization)
     end
 
@@ -27,8 +29,8 @@ module Labels
     def find_or_create_label
       new_label = available_labels.find_by(title: title)
 
-      if new_label.nil? && (skip_authorization || Ability.allowed?(current_user, :admin_label, project))
-        new_label = Labels::CreateService.new(params).execute(project: project)
+      if new_label.nil? && (skip_authorization || Ability.allowed?(current_user, :admin_label, parent))
+        new_label = Labels::CreateService.new(params).execute(parent_type.to_sym => parent)
       end
 
       new_label
@@ -37,5 +39,13 @@ module Labels
     def title
       params[:title] || params[:name]
     end
+
+    def parent_type
+      parent.model_name.param_key
+    end
+
+    def parent_is_group?
+      parent_type == "group"
+    end
   end
 end
diff --git a/spec/finders/labels_finder_spec.rb b/spec/finders/labels_finder_spec.rb
index 06031aee2173f805a95b552a0d4c1384ff2e42de..dc76efea35bb4355f07b477f831a501ca04cc761 100644
--- a/spec/finders/labels_finder_spec.rb
+++ b/spec/finders/labels_finder_spec.rb
@@ -5,6 +5,8 @@ describe LabelsFinder do
     let(:group_1) { create(:group) }
     let(:group_2) { create(:group) }
     let(:group_3) { create(:group) }
+    let(:private_group_1) { create(:group, :private) }
+    let(:private_subgroup_1) { create(:group, :private, parent: private_group_1) }
 
     let(:project_1) { create(:project, namespace: group_1) }
     let(:project_2) { create(:project, namespace: group_2) }
@@ -20,6 +22,8 @@ describe LabelsFinder do
     let!(:group_label_1) { create(:group_label, group: group_1, title: 'Label 1 (group)') }
     let!(:group_label_2) { create(:group_label, group: group_1, title: 'Group Label 2') }
     let!(:group_label_3) { create(:group_label, group: group_2, title: 'Group Label 3') }
+    let!(:private_group_label_1) { create(:group_label, group: private_group_1, title: 'Private Group Label 1') }
+    let!(:private_subgroup_label_1) { create(:group_label, group: private_subgroup_1, title: 'Private Sub Group Label 1') }
 
     let(:user) { create(:user) }
 
@@ -66,6 +70,25 @@ describe LabelsFinder do
           expect(finder.execute).to eq [group_label_2, group_label_1]
         end
       end
+
+      context 'when including labels from group ancestors', :nested_groups do
+        it 'returns labels from group and its ancestors' do
+          private_group_1.add_developer(user)
+          private_subgroup_1.add_developer(user)
+
+          finder = described_class.new(user, group_id: private_subgroup_1.id, only_group_labels: true, include_ancestor_groups: true)
+
+          expect(finder.execute).to eq [private_group_label_1, private_subgroup_label_1]
+        end
+
+        it 'ignores labels from groups which user can not read' do
+          private_subgroup_1.add_developer(user)
+
+          finder = described_class.new(user, group_id: private_subgroup_1.id, only_group_labels: true, include_ancestor_groups: true)
+
+          expect(finder.execute).to eq [private_subgroup_label_1]
+        end
+      end
     end
 
     context 'filtering by project_id' do
diff --git a/spec/services/labels/find_or_create_service_spec.rb b/spec/services/labels/find_or_create_service_spec.rb
index 78aa5d442e7178991aa238b7808dba778473decf..68d5660445acbe6fc5c72d8f268dd2a8c0442dce 100644
--- a/spec/services/labels/find_or_create_service_spec.rb
+++ b/spec/services/labels/find_or_create_service_spec.rb
@@ -15,47 +15,79 @@ describe Labels::FindOrCreateService do
 
     context 'when acting on behalf of a specific user' do
       let(:user) { create(:user) }
-      subject(:service) { described_class.new(user, project, params) }
-      before do
-        project.add_developer(user)
-      end
 
-      context 'when label does not exist at group level' do
-        it 'creates a new label at project level' do
-          expect { service.execute }.to change(project.labels, :count).by(1)
+      context 'when finding labels on project level' do
+        subject(:service) { described_class.new(user, project, params) }
+
+        before do
+          project.add_developer(user)
         end
-      end
 
-      context 'when label exists at group level' do
-        it 'returns the group label' do
-          group_label = create(:group_label, group: group, title: 'Security')
+        context 'when label does not exist at group level' do
+          it 'creates a new label at project level' do
+            expect { service.execute }.to change(project.labels, :count).by(1)
+          end
+        end
 
-          expect(service.execute).to eq group_label
+        context 'when label exists at group level' do
+          it 'returns the group label' do
+            group_label = create(:group_label, group: group, title: 'Security')
+
+            expect(service.execute).to eq group_label
+          end
+        end
+
+        context 'when label exists at project level' do
+          it 'returns the project label' do
+            project_label = create(:label, project: project, title: 'Security')
+
+            expect(service.execute).to eq project_label
+          end
         end
       end
 
-      context 'when label does not exist at group level' do
-        it 'creates a new label at project leve' do
-          expect { service.execute }.to change(project.labels, :count).by(1)
+      context 'when finding labels on group level' do
+        subject(:service) { described_class.new(user, group, params) }
+
+        before do
+          group.add_developer(user)
+        end
+
+        context 'when label does not exist at group level' do
+          it 'creates a new label at group level' do
+            expect { service.execute }.to change(group.labels, :count).by(1)
+          end
+        end
+
+        context 'when label exists at group level' do
+          it 'returns the group label' do
+            group_label = create(:group_label, group: group, title: 'Security')
+
+            expect(service.execute).to eq group_label
+          end
         end
       end
+    end
+
+    context 'when authorization is not required' do
+      context 'when finding labels on project level' do
+        subject(:service) { described_class.new(nil, project, params) }
 
-      context 'when label exists at project level' do
         it 'returns the project label' do
           project_label = create(:label, project: project, title: 'Security')
 
-          expect(service.execute).to eq project_label
+          expect(service.execute(skip_authorization: true)).to eq project_label
         end
       end
-    end
 
-    context 'when authorization is not required' do
-      subject(:service) { described_class.new(nil, project, params) }
+      context 'when finding labels on group level' do
+        subject(:service) { described_class.new(nil, group, params) }
 
-      it 'returns the project label' do
-        project_label = create(:label, project: project, title: 'Security')
+        it 'returns the group label' do
+          group_label = create(:group_label, group: group, title: 'Security')
 
-        expect(service.execute(skip_authorization: true)).to eq project_label
+          expect(service.execute(skip_authorization: true)).to eq group_label
+        end
       end
     end
   end