From a4eb5769abb2e25148e3bbf25bf842369dea4f26 Mon Sep 17 00:00:00 2001
From: huimiu <miuhui@outlook.com>
Date: Fri, 10 Jul 2026 18:35:00 +0800
Subject: [PATCH 1/4] fix: use core env in Foundry service targets

---
 .../extensions/azure.ai.agents/extension.yaml |   2 +-
 cli/azd/extensions/azure.ai.agents/go.mod     |   7 +-
 cli/azd/extensions/azure.ai.agents/go.sum     |   2 +
 .../azure.ai.agents/internal/cmd/init.go      |   9 ++
 .../internal/cmd/init_from_code.go            |  13 +-
 .../azure.ai.agents/internal/cmd/init_test.go |  10 ++
 .../internal/cmd/resource_services.go         |  95 +++++++++++++
 .../internal/cmd/resource_services_test.go    |  63 +++++++++
 .../internal/project/agent_definition.go      | 133 +++++++++++-------
 .../internal/project/agent_definition_test.go |  50 ++++++-
 .../internal/project/config.go                |   1 -
 .../internal/project/config_test.go           |   5 -
 .../schemas/azure.ai.agent.json               |   7 -
 .../schemas/examples/complex.azure.yaml       |   6 +-
 .../schemas/examples/simple.azure.yaml        |   2 +
 .../azure.ai.connections/extension.yaml       |   2 +-
 .../extensions/azure.ai.connections/go.mod    |   9 +-
 .../extensions/azure.ai.connections/go.sum    |   2 +
 .../internal/cmd/service_target.go            |  50 ++++---
 .../internal/cmd/service_target_test.go       |  24 +++-
 .../schemas/azure.ai.connection.json          |   4 +-
 .../azure.ai.routines/extension.yaml          |   2 +-
 cli/azd/extensions/azure.ai.routines/go.mod   |   7 +-
 cli/azd/extensions/azure.ai.routines/go.sum   |   2 +
 .../internal/cmd/service_target.go            |  54 ++++---
 .../internal/cmd/service_target_test.go       |  22 +++
 .../schemas/azure.ai.routine.json             |   2 +-
 .../azure.ai.toolboxes/extension.yaml         |   2 +-
 cli/azd/extensions/azure.ai.toolboxes/go.mod  |   9 +-
 cli/azd/extensions/azure.ai.toolboxes/go.sum  |   2 +
 .../internal/cmd/service_target.go            |  65 ++++++---
 .../internal/cmd/service_target_test.go       |  16 ++-
 .../schemas/azure.ai.toolbox.json             |   2 +-
 .../microsoft.foundry/extension.yaml          |   2 +-
 34 files changed, 505 insertions(+), 178 deletions(-)

diff --git a/cli/azd/extensions/azure.ai.agents/extension.yaml b/cli/azd/extensions/azure.ai.agents/extension.yaml
index 5d7f1976c29..36c9664c952 100644
--- a/cli/azd/extensions/azure.ai.agents/extension.yaml
+++ b/cli/azd/extensions/azure.ai.agents/extension.yaml
@@ -6,7 +6,7 @@ description: Ship agents with Microsoft Foundry from your terminal. (Beta)
 usage: azd ai agent <command> [options]
 # NOTE: Make sure version.txt is in sync with this version.
 version: 1.0.0-beta.5
-requiredAzdVersion: ">=1.27.0"
+requiredAzdVersion: ">=1.27.1"
 dependencies:
   - id: azure.ai.inspector
     version: "~1.0.0-beta.1"
diff --git a/cli/azd/extensions/azure.ai.agents/go.mod b/cli/azd/extensions/azure.ai.agents/go.mod
index 7723add84c6..a1fc7a392f5 100644
--- a/cli/azd/extensions/azure.ai.agents/go.mod
+++ b/cli/azd/extensions/azure.ai.agents/go.mod
@@ -2,11 +2,6 @@ module azureaiagent
 
 go 1.26.4
 
-// TEMPORARY: local validation against the in-tree azd core (proto change for
-// provisioning preview changes). Remove before merging — the core change must
-// land first, then bump the azd dependency.
-replace github.com/azure/azure-dev/cli/azd => ../../
-
 require (
 	github.com/Azure/azure-sdk-for-go/sdk/azcore v1.21.0
 	github.com/Azure/azure-sdk-for-go/sdk/azidentity v1.14.0-beta.3
@@ -17,7 +12,7 @@ require (
 	github.com/Azure/azure-sdk-for-go/sdk/resourcemanager/containerregistry/armcontainerregistry v1.3.0-beta.3
 	github.com/Azure/azure-sdk-for-go/sdk/resourcemanager/resources/armresources v1.2.0
 	github.com/Azure/azure-sdk-for-go/sdk/resourcemanager/resources/armsubscriptions v1.3.0
-	github.com/azure/azure-dev/cli/azd v1.24.3
+	github.com/azure/azure-dev/cli/azd v1.27.1
 	github.com/braydonk/yaml v0.9.0
 	github.com/drone/envsubst v1.0.3
 	github.com/fatih/color v1.18.0
diff --git a/cli/azd/extensions/azure.ai.agents/go.sum b/cli/azd/extensions/azure.ai.agents/go.sum
index cbe8b2fbaaa..b8bb9d809cb 100644
--- a/cli/azd/extensions/azure.ai.agents/go.sum
+++ b/cli/azd/extensions/azure.ai.agents/go.sum
@@ -61,6 +61,8 @@ github.com/aymanbagabas/go-udiff v0.2.0 h1:TK0fH4MteXUDspT88n8CKzvK0X9O2xu9yQjWp
 github.com/aymanbagabas/go-udiff v0.2.0/go.mod h1:RE4Ex0qsGkTAJoQdQQCA0uG+nAzJO/pI/QwceO5fgrA=
 github.com/aymerick/douceur v0.2.0 h1:Mv+mAeH1Q+n9Fr+oyamOlAkUNPWPlA8PPGR0QAaYuPk=
 github.com/aymerick/douceur v0.2.0/go.mod h1:wlT5vV2O3h55X9m7iVYN0TBM0NH/MmbLnd30/FjWUq4=
+github.com/azure/azure-dev/cli/azd v1.27.1 h1:0SrTTBDSG9huHfgt6m89EminAErKtpmOi9gQ+b/T5aw=
+github.com/azure/azure-dev/cli/azd v1.27.1/go.mod h1:Ge7QaU9PoJM7i6J0xArDoQCf2tUn6O7OIKkoItxFTA8=
 github.com/bahlo/generic-list-go v0.2.0 h1:5sz/EEAK+ls5wF+NeqDpk5+iNdMDXrh3z3nPnH1Wvgk=
 github.com/bahlo/generic-list-go v0.2.0/go.mod h1:2KvAjgMlE5NNynlg/5iLrrCCZ2+5xWbdbCW3pNTGyYg=
 github.com/benbjohnson/clock v1.3.5 h1:VvXlSJBzZpA/zum6Sj74hxwYI2DIxRWuNIoXAzHZz5o=
diff --git a/cli/azd/extensions/azure.ai.agents/internal/cmd/init.go b/cli/azd/extensions/azure.ai.agents/internal/cmd/init.go
index 158474be4ee..51def1c2cee 100644
--- a/cli/azd/extensions/azure.ai.agents/internal/cmd/init.go
+++ b/cli/azd/extensions/azure.ai.agents/internal/cmd/init.go
@@ -2857,6 +2857,7 @@ func (a *InitAction) addToProject(ctx context.Context, targetDir string, agentMa
 	if err != nil {
 		return err
 	}
+	agentEnvironment := project.AgentEnvironment(containerDef)
 
 	serviceConfig := &azdext.ServiceConfig{
 		Name:                 a.serviceNameOverride,
@@ -2890,6 +2891,14 @@ func (a *InitAction) addToProject(ctx context.Context, targetDir string, agentMa
 	if _, err := a.azdClient.Project().AddService(ctx, req); err != nil {
 		return fmt.Errorf("adding agent service to project: %w", err)
 	}
+	if err := setServiceEnvironment(
+		ctx,
+		a.azdClient,
+		a.serviceNameOverride,
+		agentEnvironment,
+	); err != nil {
+		return err
+	}
 
 	// Emit the sibling Foundry resource services (project + deployments,
 	// connections, toolboxes) and wire the agent's uses: to them. A selected
diff --git a/cli/azd/extensions/azure.ai.agents/internal/cmd/init_from_code.go b/cli/azd/extensions/azure.ai.agents/internal/cmd/init_from_code.go
index 7eb3264bd54..8d6089c8798 100644
--- a/cli/azd/extensions/azure.ai.agents/internal/cmd/init_from_code.go
+++ b/cli/azd/extensions/azure.ai.agents/internal/cmd/init_from_code.go
@@ -832,6 +832,7 @@ func (a *InitFromCodeAction) addToProject(
 	if err != nil {
 		return err
 	}
+	agentEnvironment := project.AgentEnvironment(*definition)
 
 	language := "python"
 	if !isCodeDeploy {
@@ -841,8 +842,9 @@ func (a *InitFromCodeAction) addToProject(
 		language = "csharp"
 	}
 
+	agentServiceName := strings.ReplaceAll(agentName, " ", "")
 	serviceConfig := &azdext.ServiceConfig{
-		Name:                 strings.ReplaceAll(agentName, " ", ""),
+		Name:                 agentServiceName,
 		RelativePath:         targetDir,
 		Host:                 AiAgentHost,
 		Language:             language,
@@ -869,11 +871,18 @@ func (a *InitFromCodeAction) addToProject(
 	if _, err := a.azdClient.Project().AddService(ctx, req); err != nil {
 		return fmt.Errorf("adding agent service to project: %w", err)
 	}
+	if err := setServiceEnvironment(
+		ctx,
+		a.azdClient,
+		agentServiceName,
+		agentEnvironment,
+	); err != nil {
+		return err
+	}
 
 	// Emit the sibling azure.ai.project service carrying the model deployments
 	// and wire the agent's uses: to it. A selected existing project contributes
 	// its endpoint so provision reuses it instead of creating a new project.
-	agentServiceName := strings.ReplaceAll(agentName, " ", "")
 	if err := emitResourceServices(
 		ctx, a.azdClient, agentServiceName,
 		projectNameHint(ctx, a.azdClient, a.environment.Name, a.selectedFoundryProject),
diff --git a/cli/azd/extensions/azure.ai.agents/internal/cmd/init_test.go b/cli/azd/extensions/azure.ai.agents/internal/cmd/init_test.go
index 2d865a57ee1..920b1532f64 100644
--- a/cli/azd/extensions/azure.ai.agents/internal/cmd/init_test.go
+++ b/cli/azd/extensions/azure.ai.agents/internal/cmd/init_test.go
@@ -364,6 +364,9 @@ func TestAddToProjectPreBuiltImageWritesServiceImage(t *testing.T) {
 			Protocols: []agent_yaml.ProtocolVersionRecord{
 				{Protocol: "responses", Version: "2.0.0"},
 			},
+			EnvironmentVariables: &[]agent_yaml.EnvironmentVariable{
+				{Name: "LOG_LEVEL", Value: "info"},
+			},
 		},
 	}
 
@@ -387,9 +390,16 @@ func TestAddToProjectPreBuiltImageWritesServiceImage(t *testing.T) {
 	require.Equal(t, "docker", agentService.GetLanguage())
 	require.NotNil(t, agentService.GetDocker())
 	require.NotNil(t, agentService.GetAdditionalProperties())
+	require.Empty(t, agentService.GetEnvironment())
+	require.Equal(t, map[string]any{
+		"LOG_LEVEL": "info",
+	}, server.env["my-agent"])
 
 	_, hasInlineImage := agentService.GetAdditionalProperties().GetFields()["image"]
 	require.False(t, hasInlineImage, "pre-built image must ride on the top-level service image field")
+	_, hasInlineEnvironment := agentService.GetAdditionalProperties().
+		GetFields()["environmentVariables"]
+	require.False(t, hasInlineEnvironment)
 }
 
 func TestValidateInitAgentName(t *testing.T) {
diff --git a/cli/azd/extensions/azure.ai.agents/internal/cmd/resource_services.go b/cli/azd/extensions/azure.ai.agents/internal/cmd/resource_services.go
index bce529919dd..34b220eb497 100644
--- a/cli/azd/extensions/azure.ai.agents/internal/cmd/resource_services.go
+++ b/cli/azd/extensions/azure.ai.agents/internal/cmd/resource_services.go
@@ -7,6 +7,7 @@ import (
 	"context"
 	"fmt"
 	"os"
+	"regexp"
 	"slices"
 	"strings"
 
@@ -35,6 +36,10 @@ const (
 	aiProjectServiceName = "ai-project"
 )
 
+var envReferencePattern = regexp.MustCompile(
+	`\$\{([A-Za-z_][A-Za-z0-9_]*)\}`,
+)
+
 // emitResourceServices writes the Foundry resource sibling services that the
 // agent depends on (one azure.ai.project carrying the model deployments, one
 // azure.ai.connection per connection, one azure.ai.toolbox per toolbox) and
@@ -275,6 +280,7 @@ func addResourceService(
 	cfg *structpb.Struct,
 	uses []string,
 ) error {
+	environment := serviceEnvironmentTemplates(cfg)
 	svc := &azdext.ServiceConfig{
 		Name:                 name,
 		Host:                 host,
@@ -285,6 +291,15 @@ func addResourceService(
 		return fmt.Errorf("adding %s service %q: %w", host, name, err)
 	}
 
+	if err := setServiceEnvironment(
+		ctx,
+		azdClient,
+		name,
+		environment,
+	); err != nil {
+		return err
+	}
+
 	if len(uses) > 0 {
 		if err := setServiceUses(ctx, azdClient, name, uses); err != nil {
 			return err
@@ -294,6 +309,86 @@ func addResourceService(
 	return nil
 }
 
+func serviceEnvironmentTemplates(cfg *structpb.Struct) map[string]string {
+	if cfg == nil {
+		return nil
+	}
+
+	environment := map[string]string{}
+	collectEnvironmentTemplates(cfg.AsMap(), environment)
+	if len(environment) == 0 {
+		return nil
+	}
+	return environment
+}
+
+func collectEnvironmentTemplates(value any, environment map[string]string) {
+	switch typed := value.(type) {
+	case string:
+		for _, match := range envReferencePattern.FindAllStringSubmatchIndex(
+			typed,
+			-1,
+		) {
+			if match[0] > 0 && typed[match[0]-1] == '$' {
+				continue
+			}
+			name := typed[match[2]:match[3]]
+			environment[name] = typed[match[0]:match[1]]
+		}
+	case map[string]any:
+		for _, nested := range typed {
+			collectEnvironmentTemplates(nested, environment)
+		}
+	case []any:
+		for _, nested := range typed {
+			collectEnvironmentTemplates(nested, environment)
+		}
+	}
+}
+
+func setServiceEnvironment(
+	ctx context.Context,
+	azdClient *azdext.AzdClient,
+	serviceName string,
+	environment map[string]string,
+) error {
+	if len(environment) == 0 {
+		return nil
+	}
+
+	sectionValues := make(map[string]any, len(environment))
+	for key, value := range environment {
+		sectionValues[key] = value
+	}
+	section, err := structpb.NewStruct(sectionValues)
+	if err != nil {
+		return fmt.Errorf(
+			"encoding env for service %q: %w",
+			serviceName,
+			err,
+		)
+	}
+
+	// ServiceConfig.Environment only carries expanded values.
+	// The config RPC preserves raw ${VAR} templates.
+	_, err = azdClient.Project().SetServiceConfigSection(
+		ctx,
+		&azdext.SetServiceConfigSectionRequest{
+			ServiceName: serviceName,
+			Path:        "env",
+			Section:     section,
+		},
+	)
+	if err != nil {
+		return fmt.Errorf(
+			"setting env for service %q: %w",
+			serviceName,
+			err,
+		)
+	}
+	return nil
+}
+
 // setServiceUses sets the uses: list on an existing service. uses is a real
 // core ServiceConfig field, so it is written via SetServiceConfigValue (a raw
 // map path) rather than AddService's inlined config map, which cannot carry it.
diff --git a/cli/azd/extensions/azure.ai.agents/internal/cmd/resource_services_test.go b/cli/azd/extensions/azure.ai.agents/internal/cmd/resource_services_test.go
index 0cfd1caacfc..a0dcacc1213 100644
--- a/cli/azd/extensions/azure.ai.agents/internal/cmd/resource_services_test.go
+++ b/cli/azd/extensions/azure.ai.agents/internal/cmd/resource_services_test.go
@@ -88,6 +88,53 @@ func TestReserveServiceName(t *testing.T) {
 	assert.Contains(t, err.Error(), "agent service")
 }
 
+func TestServiceEnvironmentTemplates(t *testing.T) {
+	t.Parallel()
+
+	cfg, err := project.MarshalStruct(&project.Connection{
+		Credentials: map[string]any{
+			"key": "${SEARCH_KEY}",
+		},
+		Metadata: map[string]string{
+			"server":  "${SERVER_NAME}",
+			"token":   "${{connections.search.credentials.key}}",
+			"literal": "$${LITERAL}",
+		},
+	})
+	require.NoError(t, err)
+
+	assert.Equal(t, map[string]string{
+		"SEARCH_KEY":  "${SEARCH_KEY}",
+		"SERVER_NAME": "${SERVER_NAME}",
+	}, serviceEnvironmentTemplates(cfg))
+}
+
+func TestAddResourceServiceWritesEnvironment(t *testing.T) {
+	server := &recordingProjectServer{}
+	client := newProjectRecorderClient(t, server)
+	cfg, err := project.MarshalStruct(&project.Connection{
+		Credentials: map[string]any{"key": "${SEARCH_KEY}"},
+	})
+	require.NoError(t, err)
+
+	require.NoError(t, addResourceService(
+		t.Context(),
+		client,
+		"search",
+		AiConnectionHost,
+		cfg,
+		nil,
+	))
+
+	server.mu.Lock()
+	defer server.mu.Unlock()
+	require.Len(t, server.added, 1)
+	assert.Empty(t, server.added[0].GetEnvironment())
+	assert.Equal(t, map[string]any{
+		"SEARCH_KEY": "${SEARCH_KEY}",
+	}, server.env["search"])
+}
+
 // TestCollectProjectDeployments verifies deployments are sourced only from
 // azure.ai.project services and ignore sibling hosts.
 func TestCollectProjectDeployments(t *testing.T) {
@@ -251,6 +298,7 @@ type recordingProjectServer struct {
 	mu    sync.Mutex
 	added []*azdext.ServiceConfig
 	uses  map[string][]string
+	env   map[string]map[string]any
 	// configValues records non-"uses" SetServiceConfigValue calls keyed by path.
 	configValues map[string]configValueRecord
 	// existing is returned by Get to simulate services already present in the
@@ -315,6 +363,21 @@ func (s *recordingProjectServer) SetServiceConfigValue(
 	return &azdext.EmptyResponse{}, nil
 }
 
+func (s *recordingProjectServer) SetServiceConfigSection(
+	_ context.Context,
+	req *azdext.SetServiceConfigSectionRequest,
+) (*azdext.EmptyResponse, error) {
+	s.mu.Lock()
+	defer s.mu.Unlock()
+	if s.env == nil {
+		s.env = map[string]map[string]any{}
+	}
+	if req.Path == "env" && req.Section != nil {
+		s.env[req.ServiceName] = req.Section.AsMap()
+	}
+	return &azdext.EmptyResponse{}, nil
+}
+
 // newProjectRecorderClient spins up an in-process gRPC server backed by the
 // supplied project server stub and returns a client wired to its address.
 func newProjectRecorderClient(t *testing.T, server azdext.ProjectServiceServer) *azdext.AzdClient {
diff --git a/cli/azd/extensions/azure.ai.agents/internal/project/agent_definition.go b/cli/azd/extensions/azure.ai.agents/internal/project/agent_definition.go
index 0d97d24c693..74ffe9324eb 100644
--- a/cli/azd/extensions/azure.ai.agents/internal/project/agent_definition.go
+++ b/cli/azd/extensions/azure.ai.agents/internal/project/agent_definition.go
@@ -8,6 +8,7 @@ import (
 	"log"
 	"maps"
 	"os"
+	"slices"
 	"sync"
 
 	"azureaiagent/internal/exterrors"
@@ -83,11 +84,12 @@ func WarnLegacyAgentShape(source AgentDefinitionSource) {
 type AgentDefinitionInline struct {
 	agent_yaml.AgentDefinition `json:",inline"`
 	Protocols                  []agent_yaml.ProtocolVersionRecord `json:"protocols,omitempty"`
-	EnvironmentVariables       *[]agent_yaml.EnvironmentVariable  `json:"environmentVariables,omitempty"`
-	AgentEndpoint              *agent_yaml.AgentEndpoint          `json:"agentEndpoint,omitempty"`
-	AgentCard                  *agent_yaml.AgentCard              `json:"agentCard,omitempty"`
-	CodeConfiguration          *agent_yaml.CodeConfiguration      `json:"codeConfiguration,omitempty"`
-	Policies                   []agent_yaml.Policy                `json:"policies,omitempty"`
+	// EnvironmentVariables reads the deprecated inline shape.
+	EnvironmentVariables *[]agent_yaml.EnvironmentVariable `json:"environmentVariables,omitempty"`
+	AgentEndpoint        *agent_yaml.AgentEndpoint         `json:"agentEndpoint,omitempty"`
+	AgentCard            *agent_yaml.AgentCard             `json:"agentCard,omitempty"`
+	CodeConfiguration    *agent_yaml.CodeConfiguration     `json:"codeConfiguration,omitempty"`
+	Policies             []agent_yaml.Policy               `json:"policies,omitempty"`
 }
 
 // agentDefinitionToInline splits a ContainerAgent into the inline definition,
@@ -96,13 +98,12 @@ type AgentDefinitionInline struct {
 // returned separately so the caller can place them on their respective homes.
 func agentDefinitionToInline(ca agent_yaml.ContainerAgent) (AgentDefinitionInline, *ContainerSettings, string) {
 	inline := AgentDefinitionInline{
-		AgentDefinition:      ca.AgentDefinition,
-		Protocols:            ca.Protocols,
-		EnvironmentVariables: ca.EnvironmentVariables,
-		AgentEndpoint:        ca.AgentEndpoint,
-		AgentCard:            ca.AgentCard,
-		CodeConfiguration:    ca.CodeConfiguration,
-		Policies:             ca.Policies,
+		AgentDefinition:   ca.AgentDefinition,
+		Protocols:         ca.Protocols,
+		AgentEndpoint:     ca.AgentEndpoint,
+		AgentCard:         ca.AgentCard,
+		CodeConfiguration: ca.CodeConfiguration,
+		Policies:          ca.Policies,
 	}
 
 	var container *ContainerSettings
@@ -118,12 +119,21 @@ func agentDefinitionToInline(ca agent_yaml.ContainerAgent) (AgentDefinitionInlin
 // toContainerAgent rebuilds the agent_yaml.ContainerAgent from the inline
 // definition, the CPU/memory carried in the `container` config, and the image
 // carried on the core service field.
-func (d AgentDefinitionInline) toContainerAgent(container *ContainerSettings, image string) agent_yaml.ContainerAgent {
+func (d AgentDefinitionInline) toContainerAgent(
+	container *ContainerSettings,
+	image string,
+	environment map[string]string,
+) agent_yaml.ContainerAgent {
+	environmentVariables := d.EnvironmentVariables
+	if len(environment) > 0 {
+		environmentVariables = environmentVariablesFromMap(environment)
+	}
+
 	ca := agent_yaml.ContainerAgent{
 		AgentDefinition:      d.AgentDefinition,
 		Image:                image,
 		Protocols:            d.Protocols,
-		EnvironmentVariables: d.EnvironmentVariables,
+		EnvironmentVariables: environmentVariables,
 		AgentEndpoint:        d.AgentEndpoint,
 		AgentCard:            d.AgentCard,
 		CodeConfiguration:    d.CodeConfiguration,
@@ -140,6 +150,40 @@ func (d AgentDefinitionInline) toContainerAgent(container *ContainerSettings, im
 	return ca
 }
 
+// AgentEnvironment converts an agent environment list to a map.
+func AgentEnvironment(ca agent_yaml.ContainerAgent) map[string]string {
+	if ca.EnvironmentVariables == nil || len(*ca.EnvironmentVariables) == 0 {
+		return nil
+	}
+
+	environment := make(map[string]string, len(*ca.EnvironmentVariables))
+	for _, variable := range *ca.EnvironmentVariables {
+		environment[variable.Name] = variable.Value
+	}
+	return environment
+}
+
+func environmentVariablesFromMap(
+	environment map[string]string,
+) *[]agent_yaml.EnvironmentVariable {
+	if len(environment) == 0 {
+		return nil
+	}
+
+	variables := make(
+		[]agent_yaml.EnvironmentVariable,
+		0,
+		len(environment),
+	)
+	for _, name := range slices.Sorted(maps.Keys(environment)) {
+		variables = append(variables, agent_yaml.EnvironmentVariable{
+			Name:  name,
+			Value: environment[name],
+		})
+	}
+	return &variables
+}
+
 // structHasKind reports whether the struct carries a non-empty string `kind`,
 // the marker that an agent definition is present in a service entry's inline or
 // config properties.
@@ -197,7 +241,11 @@ func AgentDefinitionFromService(
 		}
 	}
 
-	ca, isHosted, err := agentDefinitionFromStruct(inlineStruct, svc.GetImage())
+	ca, isHosted, err := agentDefinitionFromStruct(
+		inlineStruct,
+		svc.GetImage(),
+		svc.GetEnvironment(),
+	)
 	return ca, isHosted, true, source, err
 }
 
@@ -228,11 +276,7 @@ func ServiceConfigProps(svc *azdext.ServiceConfig) *structpb.Struct {
 	return svc.GetConfig()
 }
 
-// UpsertAgentEnvVars adds or updates environment variables on the agent
-// definition carried inline on the service entry, preserving every other key.
-// It is used by commands that mutate the definition (e.g. `optimize apply`).
-// Returns an error when the service carries no inline definition; callers fall
-// back to mutating a legacy on-disk agent.yaml in that case.
+// UpsertAgentEnvVars updates the service-level environment map.
 func UpsertAgentEnvVars(svc *azdext.ServiceConfig, kv map[string]string) error {
 	ca, _, found, source, err := AgentDefinitionFromService(svc)
 	if err != nil {
@@ -242,40 +286,19 @@ func UpsertAgentEnvVars(svc *azdext.ServiceConfig, kv map[string]string) error {
 		return fmt.Errorf("service %q does not carry an inline agent definition", svc.GetName())
 	}
 
-	envVars := []agent_yaml.EnvironmentVariable{}
-	if ca.EnvironmentVariables != nil {
-		envVars = *ca.EnvironmentVariables
-	}
-	for key, value := range kv {
-		idx := -1
-		for i := range envVars {
-			if envVars[i].Name == key {
-				idx = i
-				break
-			}
-		}
-		if idx >= 0 {
-			envVars[idx].Value = value
-		} else {
-			envVars = append(envVars, agent_yaml.EnvironmentVariable{Name: key, Value: value})
-		}
-	}
-	ca.EnvironmentVariables = &envVars
-
-	cfg, err := LoadServiceTargetAgentConfig(svc)
-	if err != nil {
-		return err
-	}
-
-	props, err := AgentDefinitionToServiceProperties(ca, cfg)
-	if err != nil {
-		return err
+	environment := AgentEnvironment(ca)
+	if environment == nil {
+		environment = map[string]string{}
 	}
+	maps.Copy(environment, kv)
+	svc.Environment = environment
 
+	props := svc.GetAdditionalProperties()
 	if source == AgentDefinitionSourceLegacyConfig {
-		svc.Config = props
-	} else {
-		svc.AdditionalProperties = props
+		props = svc.GetConfig()
+	}
+	if props != nil {
+		delete(props.Fields, "environmentVariables")
 	}
 	return nil
 }
@@ -318,7 +341,11 @@ func SetAgentContainerSettings(svc *azdext.ServiceConfig, container *ContainerSe
 // struct that carries the agent definition as service-level properties. coreImage
 // is the value of the service's `image` field, which is carried on the core
 // [azdext.ServiceConfig] rather than in the inline property bag.
-func agentDefinitionFromStruct(s *structpb.Struct, coreImage string) (agent_yaml.ContainerAgent, bool, error) {
+func agentDefinitionFromStruct(
+	s *structpb.Struct,
+	coreImage string,
+	environment map[string]string,
+) (agent_yaml.ContainerAgent, bool, error) {
 	var inline AgentDefinitionInline
 	if err := UnmarshalStruct(s, &inline); err != nil {
 		return agent_yaml.ContainerAgent{}, false, exterrors.Validation(
@@ -341,7 +368,7 @@ func agentDefinitionFromStruct(s *structpb.Struct, coreImage string) (agent_yaml
 		)
 	}
 
-	ca := inline.toContainerAgent(cfg.Container, coreImage)
+	ca := inline.toContainerAgent(cfg.Container, coreImage, environment)
 
 	// Validate the inline definition with the same rules the on-disk agent.yaml
 	// path uses (kind, name format, policies), so an inline definition cannot
diff --git a/cli/azd/extensions/azure.ai.agents/internal/project/agent_definition_test.go b/cli/azd/extensions/azure.ai.agents/internal/project/agent_definition_test.go
index 821f8ad7e18..376b2a8d4ca 100644
--- a/cli/azd/extensions/azure.ai.agents/internal/project/agent_definition_test.go
+++ b/cli/azd/extensions/azure.ai.agents/internal/project/agent_definition_test.go
@@ -12,6 +12,7 @@ import (
 
 	"github.com/azure/azure-dev/cli/azd/pkg/azdext"
 	"github.com/stretchr/testify/require"
+	"google.golang.org/protobuf/types/known/structpb"
 )
 
 // sampleContainerAgent returns a hosted ContainerAgent with the fields that the
@@ -51,11 +52,14 @@ func TestAgentDefinitionRoundTrip(t *testing.T) {
 
 	props, err := AgentDefinitionToServiceProperties(ca, extra)
 	require.NoError(t, err)
+	_, hasInlineEnvironment := props.GetFields()["environmentVariables"]
+	require.False(t, hasInlineEnvironment)
 
 	svc := &azdext.ServiceConfig{
 		Name:                 "basic-agent",
 		Host:                 "azure.ai.agent",
 		AdditionalProperties: props,
+		Environment:          AgentEnvironment(ca),
 	}
 
 	got, isHosted, found, source, err := AgentDefinitionFromService(svc)
@@ -110,6 +114,35 @@ func TestAgentDefinitionFromService_LegacyConfigShape(t *testing.T) {
 	require.Equal(t, "basic-agent", got.Name)
 }
 
+func TestAgentDefinitionFromService_LegacyEnvironment(t *testing.T) {
+	props, err := AgentDefinitionToServiceProperties(
+		sampleContainerAgent(),
+		nil,
+	)
+	require.NoError(t, err)
+	legacyEnvironment, err := structpb.NewValue([]any{
+		map[string]any{
+			"name":  "LEGACY_KEY",
+			"value": "${LEGACY_KEY}",
+		},
+	})
+	require.NoError(t, err)
+	props.Fields["environmentVariables"] = legacyEnvironment
+
+	svc := &azdext.ServiceConfig{
+		Name:   "basic-agent",
+		Host:   "azure.ai.agent",
+		Config: props,
+	}
+	got, _, found, source, err := AgentDefinitionFromService(svc)
+	require.NoError(t, err)
+	require.True(t, found)
+	require.Equal(t, AgentDefinitionSourceLegacyConfig, source)
+	require.Equal(t, map[string]string{
+		"LEGACY_KEY": "${LEGACY_KEY}",
+	}, AgentEnvironment(got))
+}
+
 // TestAgentDefinitionFromService_NoDefinition verifies that a service without an
 // inline definition reports not-found (callers then fall back to disk).
 func TestAgentDefinitionFromService_NoDefinition(t *testing.T) {
@@ -211,9 +244,15 @@ func TestLoadAgentDefinition_DiskFallback(t *testing.T) {
 // TestUpsertAgentEnvVars verifies that env vars are added/updated on the inline
 // definition while preserving the other definition keys.
 func TestUpsertAgentEnvVars(t *testing.T) {
-	props, err := AgentDefinitionToServiceProperties(sampleContainerAgent(), nil)
+	ca := sampleContainerAgent()
+	props, err := AgentDefinitionToServiceProperties(ca, nil)
 	require.NoError(t, err)
-	svc := &azdext.ServiceConfig{Name: "basic-agent", Host: "azure.ai.agent", AdditionalProperties: props}
+	svc := &azdext.ServiceConfig{
+		Name:                 "basic-agent",
+		Host:                 "azure.ai.agent",
+		AdditionalProperties: props,
+		Environment:          AgentEnvironment(ca),
+	}
 
 	require.NoError(t, UpsertAgentEnvVars(svc, map[string]string{
 		"FOUNDRY_MODEL_DEPLOYMENT_NAME": "gpt-4o", // update existing
@@ -225,11 +264,10 @@ func TestUpsertAgentEnvVars(t *testing.T) {
 	require.True(t, found)
 	require.Equal(t, "basic-agent", got.Name) // other keys preserved
 	require.NotNil(t, got.EnvironmentVariables)
+	_, hasInlineEnvironment := props.GetFields()["environmentVariables"]
+	require.False(t, hasInlineEnvironment)
 
-	values := map[string]string{}
-	for _, ev := range *got.EnvironmentVariables {
-		values[ev.Name] = ev.Value
-	}
+	values := AgentEnvironment(got)
 	require.Equal(t, "gpt-4o", values["FOUNDRY_MODEL_DEPLOYMENT_NAME"])
 	require.Equal(t, "cand-1", values["OPTIMIZATION_CANDIDATE_ID"])
 }
diff --git a/cli/azd/extensions/azure.ai.agents/internal/project/config.go b/cli/azd/extensions/azure.ai.agents/internal/project/config.go
index b37b190409e..ce5a633a684 100644
--- a/cli/azd/extensions/azure.ai.agents/internal/project/config.go
+++ b/cli/azd/extensions/azure.ai.agents/internal/project/config.go
@@ -45,7 +45,6 @@ type ServiceTargetAgentConfig struct {
 	// Foundry project. Its presence is the brownfield signal that makes provision
 	// connect to that project instead of creating a new one.
 	Endpoint        string             `json:"endpoint,omitempty"`
-	Environment     map[string]string  `json:"env,omitempty"`
 	Container       *ContainerSettings `json:"container,omitempty"`
 	Deployments     []Deployment       `json:"deployments,omitempty"`
 	Resources       []Resource         `json:"resources,omitempty"`
diff --git a/cli/azd/extensions/azure.ai.agents/internal/project/config_test.go b/cli/azd/extensions/azure.ai.agents/internal/project/config_test.go
index 33c8819ff18..ac4fa16b397 100644
--- a/cli/azd/extensions/azure.ai.agents/internal/project/config_test.go
+++ b/cli/azd/extensions/azure.ai.agents/internal/project/config_test.go
@@ -147,7 +147,6 @@ func TestServiceTargetAgentConfig_MultipleToolboxes(t *testing.T) {
 // alongside other ServiceTargetAgentConfig fields.
 func TestServiceTargetAgentConfig_WithOtherFields(t *testing.T) {
 	original := ServiceTargetAgentConfig{
-		Environment: map[string]string{"KEY": "VALUE"},
 		Deployments: []Deployment{
 			{
 				Name: "test-deployment",
@@ -187,10 +186,6 @@ func TestServiceTargetAgentConfig_WithOtherFields(t *testing.T) {
 		t.Fatalf("UnmarshalStruct failed: %v", err)
 	}
 
-	if roundTripped.Environment["KEY"] != "VALUE" {
-		t.Errorf("Expected env KEY=VALUE, got '%s'", roundTripped.Environment["KEY"])
-	}
-
 	if len(roundTripped.Deployments) != 1 {
 		t.Fatalf("Expected 1 deployment, got %d", len(roundTripped.Deployments))
 	}
diff --git a/cli/azd/extensions/azure.ai.agents/schemas/azure.ai.agent.json b/cli/azd/extensions/azure.ai.agents/schemas/azure.ai.agent.json
index a6ac2d23f0d..1e3acc4b03a 100644
--- a/cli/azd/extensions/azure.ai.agents/schemas/azure.ai.agent.json
+++ b/cli/azd/extensions/azure.ai.agents/schemas/azure.ai.agent.json
@@ -4,13 +4,6 @@
   "description": "Custom configuration for the Azure AI Agent Service target",
   "type": "object",
   "properties": {
-    "env": {
-      "type": "object",
-      "description": "Environment variables as key-value pairs",
-      "additionalProperties": {
-        "type": "string"
-      }
-    },
     "container": {
       "$ref": "#/definitions/ContainerSettings"
     },
diff --git a/cli/azd/extensions/azure.ai.agents/schemas/examples/complex.azure.yaml b/cli/azd/extensions/azure.ai.agents/schemas/examples/complex.azure.yaml
index 1f299dd05bb..4889c2f7b03 100644
--- a/cli/azd/extensions/azure.ai.agents/schemas/examples/complex.azure.yaml
+++ b/cli/azd/extensions/azure.ai.agents/schemas/examples/complex.azure.yaml
@@ -46,6 +46,8 @@ services:
     host: azure.ai.connection
     uses:
       - ai-project
+    env:
+      SEARCH_API_KEY: ${SEARCH_API_KEY}
     category: CognitiveSearch
     target: https://my-search.search.windows.net
     authType: ApiKey
@@ -108,7 +110,7 @@ services:
       - research-tools
     env:
       LOG_LEVEL: info
-      MODEL_ENDPOINT: ${{project.endpoint}}
+      MODEL_ENDPOINT: $${{project.endpoint}}
     protocols:
       - protocol: a2a
         version: "0.2"
@@ -143,6 +145,8 @@ services:
     host: azure.ai.routine
     uses:
       - researcher
+    env:
+      DIGEST_TOPIC: ${DIGEST_TOPIC}
     description: Summarize the day's documents every night.
     triggers:
       default:
diff --git a/cli/azd/extensions/azure.ai.agents/schemas/examples/simple.azure.yaml b/cli/azd/extensions/azure.ai.agents/schemas/examples/simple.azure.yaml
index 38197ca2346..6c51d4ab962 100644
--- a/cli/azd/extensions/azure.ai.agents/schemas/examples/simple.azure.yaml
+++ b/cli/azd/extensions/azure.ai.agents/schemas/examples/simple.azure.yaml
@@ -25,3 +25,5 @@ services:
     kind: hosted
     name: assistant
     description: A simple assistant.
+    env:
+      LOG_LEVEL: info
diff --git a/cli/azd/extensions/azure.ai.connections/extension.yaml b/cli/azd/extensions/azure.ai.connections/extension.yaml
index a1d9d0ee90d..39a83f9571f 100644
--- a/cli/azd/extensions/azure.ai.connections/extension.yaml
+++ b/cli/azd/extensions/azure.ai.connections/extension.yaml
@@ -17,4 +17,4 @@ tags:
     - connection
 usage: azd ai connection <command> [options]
 version: 1.0.0-beta.2
-requiredAzdVersion: ">=1.27.0"
+requiredAzdVersion: ">=1.27.1"
diff --git a/cli/azd/extensions/azure.ai.connections/go.mod b/cli/azd/extensions/azure.ai.connections/go.mod
index 5b0958a2ee5..0c9a3fa6472 100644
--- a/cli/azd/extensions/azure.ai.connections/go.mod
+++ b/cli/azd/extensions/azure.ai.connections/go.mod
@@ -2,20 +2,16 @@ module azure.ai.connections
 
 go 1.26.4
 
-// TEMPORARY: local validation against the in-tree azd core for the shared
-// pkg/foundry helpers (the $ref resolver and ${VAR}/${{...}} expander). Remove
-// before merging — the core change must land first, then bump the azd dependency.
-replace github.com/azure/azure-dev/cli/azd => ../../
-
 require (
 	github.com/Azure/azure-sdk-for-go/sdk/azcore v1.20.0
 	github.com/Azure/azure-sdk-for-go/sdk/azidentity v1.13.1
 	github.com/Azure/azure-sdk-for-go/sdk/resourcemanager/cognitiveservices/armcognitiveservices/v2 v2.0.0
-	github.com/azure/azure-dev/cli/azd v1.25.0
+	github.com/azure/azure-dev/cli/azd v1.27.1
 	github.com/fatih/color v1.18.0
 	github.com/spf13/cobra v1.10.1
 	github.com/stretchr/testify v1.11.1
 	google.golang.org/grpc v1.80.0
+	google.golang.org/protobuf v1.36.11
 )
 
 require (
@@ -107,6 +103,5 @@ require (
 	golang.org/x/text v0.38.0 // indirect
 	golang.org/x/time v0.9.0 // indirect
 	google.golang.org/genproto/googleapis/rpc v0.0.0-20260401024825-9d38bb4040a9 // indirect
-	google.golang.org/protobuf v1.36.11 // indirect
 	gopkg.in/yaml.v3 v3.0.1 // indirect
 )
diff --git a/cli/azd/extensions/azure.ai.connections/go.sum b/cli/azd/extensions/azure.ai.connections/go.sum
index 63edde352c2..bad69da9451 100644
--- a/cli/azd/extensions/azure.ai.connections/go.sum
+++ b/cli/azd/extensions/azure.ai.connections/go.sum
@@ -51,6 +51,8 @@ github.com/aymanbagabas/go-udiff v0.2.0 h1:TK0fH4MteXUDspT88n8CKzvK0X9O2xu9yQjWp
 github.com/aymanbagabas/go-udiff v0.2.0/go.mod h1:RE4Ex0qsGkTAJoQdQQCA0uG+nAzJO/pI/QwceO5fgrA=
 github.com/aymerick/douceur v0.2.0 h1:Mv+mAeH1Q+n9Fr+oyamOlAkUNPWPlA8PPGR0QAaYuPk=
 github.com/aymerick/douceur v0.2.0/go.mod h1:wlT5vV2O3h55X9m7iVYN0TBM0NH/MmbLnd30/FjWUq4=
+github.com/azure/azure-dev/cli/azd v1.27.1 h1:0SrTTBDSG9huHfgt6m89EminAErKtpmOi9gQ+b/T5aw=
+github.com/azure/azure-dev/cli/azd v1.27.1/go.mod h1:Ge7QaU9PoJM7i6J0xArDoQCf2tUn6O7OIKkoItxFTA8=
 github.com/bahlo/generic-list-go v0.2.0 h1:5sz/EEAK+ls5wF+NeqDpk5+iNdMDXrh3z3nPnH1Wvgk=
 github.com/bahlo/generic-list-go v0.2.0/go.mod h1:2KvAjgMlE5NNynlg/5iLrrCCZ2+5xWbdbCW3pNTGyYg=
 github.com/benbjohnson/clock v1.3.5 h1:VvXlSJBzZpA/zum6Sj74hxwYI2DIxRWuNIoXAzHZz5o=
diff --git a/cli/azd/extensions/azure.ai.connections/internal/cmd/service_target.go b/cli/azd/extensions/azure.ai.connections/internal/cmd/service_target.go
index 975a7bb4de8..faa5b6716af 100644
--- a/cli/azd/extensions/azure.ai.connections/internal/cmd/service_target.go
+++ b/cli/azd/extensions/azure.ai.connections/internal/cmd/service_target.go
@@ -41,18 +41,21 @@ type connectionServiceConfig struct {
 // project's connection; the resource name is the service key. Package and Publish are
 // no-ops because a connection has no build artifact.
 type connectionServiceTarget struct {
-	azdClient     *azdext.AzdClient
-	serviceConfig *azdext.ServiceConfig
+	azdClient *azdext.AzdClient
 }
 
 // newConnectionServiceTarget creates the azure.ai.connection service-target provider.
-func newConnectionServiceTarget(azdClient *azdext.AzdClient) azdext.ServiceTargetProvider {
+func newConnectionServiceTarget(
+	azdClient *azdext.AzdClient,
+) azdext.ServiceTargetProvider {
 	return &connectionServiceTarget{azdClient: azdClient}
 }
 
-// Initialize stores the service configuration; no other setup is required.
-func (p *connectionServiceTarget) Initialize(ctx context.Context, serviceConfig *azdext.ServiceConfig) error {
-	p.serviceConfig = serviceConfig
+// Initialize requires no setup.
+func (p *connectionServiceTarget) Initialize(
+	_ context.Context,
+	_ *azdext.ServiceConfig,
+) error {
 	return nil
 }
 
@@ -105,8 +108,8 @@ func (p *connectionServiceTarget) Publish(
 }
 
 // Deploy upserts the connection on its project via an idempotent ARM CreateOrUpdate.
-// ${VAR} references in the target and credential values resolve against the azd
-// environment; Foundry server-side ${{...}} expressions pass through untouched.
+// ${VAR} references resolve from the forwarded service environment.
+// Foundry server-side ${{...}} expressions pass through untouched.
 // Removing the service from azure.yaml stops azd managing the connection but does not
 // delete it (use `azd ai connection delete`).
 func (p *connectionServiceTarget) Deploy(
@@ -122,7 +125,7 @@ func (p *connectionServiceTarget) Deploy(
 	}
 	name := serviceConfig.GetName()
 
-	env, err := p.currentEnvValues(ctx)
+	env, err := p.environmentValues(ctx, serviceConfig)
 	if err != nil {
 		return nil, err
 	}
@@ -189,16 +192,27 @@ func parseConnectionServiceConfig(svc *azdext.ServiceConfig) (*connectionService
 	return cfg, nil
 }
 
-// currentEnvValues loads all key-value pairs from the active azd environment, used to
-// resolve ${VAR} references in connection fields at deploy time.
-func (p *connectionServiceTarget) currentEnvValues(ctx context.Context) (map[string]string, error) {
-	current, err := p.azdClient.Environment().GetCurrent(ctx, &azdext.EmptyRequest{})
+func (p *connectionServiceTarget) environmentValues(
+	ctx context.Context,
+	serviceConfig *azdext.ServiceConfig,
+) (map[string]string, error) {
+	if environment := serviceConfig.GetEnvironment(); len(environment) > 0 {
+		return environment, nil
+	}
+
+	current, err := p.azdClient.Environment().GetCurrent(
+		ctx,
+		&azdext.EmptyRequest{},
+	)
 	if err != nil {
 		return nil, fmt.Errorf("resolving current azd environment: %w", err)
 	}
-	resp, err := p.azdClient.Environment().GetValues(ctx, &azdext.GetEnvironmentRequest{
-		Name: current.GetEnvironment().GetName(),
-	})
+	resp, err := p.azdClient.Environment().GetValues(
+		ctx,
+		&azdext.GetEnvironmentRequest{
+			Name: current.GetEnvironment().GetName(),
+		},
+	)
 	if err != nil {
 		return nil, fmt.Errorf("loading azd environment values: %w", err)
 	}
@@ -209,9 +223,7 @@ func (p *connectionServiceTarget) currentEnvValues(ctx context.Context) (map[str
 	return values, nil
 }
 
-// resolveConnectionEnv expands ${VAR} references against the azd environment while
-// preserving Foundry server-side ${{...}} expressions. On expansion error the original
-// value is returned unchanged.
+// resolveConnectionEnv expands ${VAR} from the service environment.
 func resolveConnectionEnv(value string, env map[string]string) string {
 	resolved, err := foundry.ExpandEnv(value, func(name string) string { return env[name] })
 	if err != nil {
diff --git a/cli/azd/extensions/azure.ai.connections/internal/cmd/service_target_test.go b/cli/azd/extensions/azure.ai.connections/internal/cmd/service_target_test.go
index 60cf2cfacac..8fc7997528b 100644
--- a/cli/azd/extensions/azure.ai.connections/internal/cmd/service_target_test.go
+++ b/cli/azd/extensions/azure.ai.connections/internal/cmd/service_target_test.go
@@ -87,13 +87,29 @@ func TestConnectionCredentialArgs(t *testing.T) {
 func TestResolveConnectionEnv(t *testing.T) {
 	t.Parallel()
 
-	env := map[string]string{"SEARCH_KEY": "resolved-secret"}
+	serviceConfig := &azdext.ServiceConfig{
+		Environment: map[string]string{"SEARCH_KEY": "resolved-secret"},
+	}
+	environment, err := (&connectionServiceTarget{}).environmentValues(
+		t.Context(),
+		serviceConfig,
+	)
+	require.NoError(t, err)
 
-	// ${VAR} resolves from the azd env; Foundry ${{...}} passes through untouched.
-	assert.Equal(t, "resolved-secret", resolveConnectionEnv("${SEARCH_KEY}", env))
+	// Foundry server-side expressions pass through untouched.
+	assert.Equal(t,
+		"resolved-secret",
+		resolveConnectionEnv(
+			"${SEARCH_KEY}",
+			environment,
+		),
+	)
 	assert.Equal(t,
 		"${{connections.x.credentials.key}}",
-		resolveConnectionEnv("${{connections.x.credentials.key}}", env),
+		resolveConnectionEnv(
+			"${{connections.x.credentials.key}}",
+			environment,
+		),
 	)
 }
 
diff --git a/cli/azd/extensions/azure.ai.connections/schemas/azure.ai.connection.json b/cli/azd/extensions/azure.ai.connections/schemas/azure.ai.connection.json
index f51ea03067e..c4f76754581 100644
--- a/cli/azd/extensions/azure.ai.connections/schemas/azure.ai.connection.json
+++ b/cli/azd/extensions/azure.ai.connections/schemas/azure.ai.connection.json
@@ -12,7 +12,7 @@
     },
     "target": {
       "type": "string",
-      "description": "Target endpoint URL or ARM resource ID. May contain ${VAR} (azd env, resolved client-side)."
+      "description": "Target endpoint URL or ARM resource ID. May contain ${VAR}; declare each referenced variable in the service-level env object."
     },
     "authType": {
       "type": "string",
@@ -38,7 +38,7 @@
     },
     "credentials": {
       "type": "object",
-      "description": "Credentials. Values may contain ${VAR} (azd env, resolved client-side) or ${{...}} (Foundry server-side resolution, passed through untouched).",
+      "description": "Credentials. Values may contain ${VAR} declared in the service-level env object or ${{...}} for Foundry server-side resolution.",
       "additionalProperties": true
     },
     "metadata": {
diff --git a/cli/azd/extensions/azure.ai.routines/extension.yaml b/cli/azd/extensions/azure.ai.routines/extension.yaml
index f34400f68da..c23c76f948c 100644
--- a/cli/azd/extensions/azure.ai.routines/extension.yaml
+++ b/cli/azd/extensions/azure.ai.routines/extension.yaml
@@ -17,4 +17,4 @@ tags:
     - routine
 usage: azd ai routine <command> [options]
 version: 1.0.0-beta.2
-requiredAzdVersion: ">=1.27.0"
+requiredAzdVersion: ">=1.27.1"
diff --git a/cli/azd/extensions/azure.ai.routines/go.mod b/cli/azd/extensions/azure.ai.routines/go.mod
index 0f60d383138..bab75ff742b 100644
--- a/cli/azd/extensions/azure.ai.routines/go.mod
+++ b/cli/azd/extensions/azure.ai.routines/go.mod
@@ -2,15 +2,10 @@ module azure.ai.routines
 
 go 1.26.4
 
-// TEMPORARY: local validation against the in-tree azd core for the shared
-// pkg/foundry helpers (the ${VAR}/${{...}} expander). Remove before merging —
-// the core change must land first, then bump the azd dependency.
-replace github.com/azure/azure-dev/cli/azd => ../../
-
 require (
 	github.com/Azure/azure-sdk-for-go/sdk/azcore v1.20.0
 	github.com/Azure/azure-sdk-for-go/sdk/azidentity v1.13.1
-	github.com/azure/azure-dev/cli/azd v1.25.0
+	github.com/azure/azure-dev/cli/azd v1.27.1
 	github.com/fatih/color v1.18.0
 	github.com/spf13/cobra v1.10.1
 	github.com/stretchr/testify v1.11.1
diff --git a/cli/azd/extensions/azure.ai.routines/go.sum b/cli/azd/extensions/azure.ai.routines/go.sum
index fccf35ac970..3988398043a 100644
--- a/cli/azd/extensions/azure.ai.routines/go.sum
+++ b/cli/azd/extensions/azure.ai.routines/go.sum
@@ -49,6 +49,8 @@ github.com/aymanbagabas/go-udiff v0.2.0 h1:TK0fH4MteXUDspT88n8CKzvK0X9O2xu9yQjWp
 github.com/aymanbagabas/go-udiff v0.2.0/go.mod h1:RE4Ex0qsGkTAJoQdQQCA0uG+nAzJO/pI/QwceO5fgrA=
 github.com/aymerick/douceur v0.2.0 h1:Mv+mAeH1Q+n9Fr+oyamOlAkUNPWPlA8PPGR0QAaYuPk=
 github.com/aymerick/douceur v0.2.0/go.mod h1:wlT5vV2O3h55X9m7iVYN0TBM0NH/MmbLnd30/FjWUq4=
+github.com/azure/azure-dev/cli/azd v1.27.1 h1:0SrTTBDSG9huHfgt6m89EminAErKtpmOi9gQ+b/T5aw=
+github.com/azure/azure-dev/cli/azd v1.27.1/go.mod h1:Ge7QaU9PoJM7i6J0xArDoQCf2tUn6O7OIKkoItxFTA8=
 github.com/bahlo/generic-list-go v0.2.0 h1:5sz/EEAK+ls5wF+NeqDpk5+iNdMDXrh3z3nPnH1Wvgk=
 github.com/bahlo/generic-list-go v0.2.0/go.mod h1:2KvAjgMlE5NNynlg/5iLrrCCZ2+5xWbdbCW3pNTGyYg=
 github.com/benbjohnson/clock v1.3.5 h1:VvXlSJBzZpA/zum6Sj74hxwYI2DIxRWuNIoXAzHZz5o=
diff --git a/cli/azd/extensions/azure.ai.routines/internal/cmd/service_target.go b/cli/azd/extensions/azure.ai.routines/internal/cmd/service_target.go
index 9203d8a3f34..8dc8d49092d 100644
--- a/cli/azd/extensions/azure.ai.routines/internal/cmd/service_target.go
+++ b/cli/azd/extensions/azure.ai.routines/internal/cmd/service_target.go
@@ -29,18 +29,21 @@ var _ azdext.ServiceTargetProvider = (*routineServiceTarget)(nil)
 // model (triggers, action, ...); the routine name is the service key. Package
 // and Publish are no-ops because a routine has no build artifact.
 type routineServiceTarget struct {
-	azdClient     *azdext.AzdClient
-	serviceConfig *azdext.ServiceConfig
+	azdClient *azdext.AzdClient
 }
 
 // newRoutineServiceTarget creates the azure.ai.routine service-target provider.
-func newRoutineServiceTarget(azdClient *azdext.AzdClient) azdext.ServiceTargetProvider {
+func newRoutineServiceTarget(
+	azdClient *azdext.AzdClient,
+) azdext.ServiceTargetProvider {
 	return &routineServiceTarget{azdClient: azdClient}
 }
 
-// Initialize stores the service configuration; no other setup is required.
-func (p *routineServiceTarget) Initialize(ctx context.Context, serviceConfig *azdext.ServiceConfig) error {
-	p.serviceConfig = serviceConfig
+// Initialize requires no setup.
+func (p *routineServiceTarget) Initialize(
+	_ context.Context,
+	_ *azdext.ServiceConfig,
+) error {
 	return nil
 }
 
@@ -111,14 +114,16 @@ func (p *routineServiceTarget) Deploy(
 	// The service key is the routine identity; ignore any name in the body.
 	body.Name = serviceConfig.GetName()
 
-	// Resolve ${VAR} references in the routine's action input against the azd
-	// environment, leaving Foundry server-side ${{...}} expressions untouched.
+	// Resolve ${VAR} against the service environment forwarded by azd.
 	if body.Action != nil {
-		env, err := p.currentEnvValues(ctx)
+		environment, err := p.environmentValues(ctx, serviceConfig)
 		if err != nil {
 			return nil, err
 		}
-		body.Action.Input = expandRoutineValue(body.Action.Input, env)
+		body.Action.Input = expandRoutineValue(
+			body.Action.Input,
+			environment,
+		)
 	}
 
 	if progress != nil {
@@ -185,16 +190,27 @@ func newRoutineServiceClient(ctx context.Context) (*routines.Client, error) {
 	), nil
 }
 
-// currentEnvValues loads all key-value pairs from the active azd environment, used to
-// resolve ${VAR} references in routine fields at deploy time.
-func (p *routineServiceTarget) currentEnvValues(ctx context.Context) (map[string]string, error) {
-	current, err := p.azdClient.Environment().GetCurrent(ctx, &azdext.EmptyRequest{})
+func (p *routineServiceTarget) environmentValues(
+	ctx context.Context,
+	serviceConfig *azdext.ServiceConfig,
+) (map[string]string, error) {
+	if environment := serviceConfig.GetEnvironment(); len(environment) > 0 {
+		return environment, nil
+	}
+
+	current, err := p.azdClient.Environment().GetCurrent(
+		ctx,
+		&azdext.EmptyRequest{},
+	)
 	if err != nil {
 		return nil, fmt.Errorf("resolving current azd environment: %w", err)
 	}
-	resp, err := p.azdClient.Environment().GetValues(ctx, &azdext.GetEnvironmentRequest{
-		Name: current.GetEnvironment().GetName(),
-	})
+	resp, err := p.azdClient.Environment().GetValues(
+		ctx,
+		&azdext.GetEnvironmentRequest{
+			Name: current.GetEnvironment().GetName(),
+		},
+	)
 	if err != nil {
 		return nil, fmt.Errorf("loading azd environment values: %w", err)
 	}
@@ -205,9 +221,7 @@ func (p *routineServiceTarget) currentEnvValues(ctx context.Context) (map[string
 	return values, nil
 }
 
-// expandRoutineValue recursively expands ${VAR} references in every string within a
-// routine value (maps, slices, scalars) against the azd environment, preserving Foundry
-// server-side ${{...}} expressions.
+// expandRoutineValue expands ${VAR} in nested routine values.
 func expandRoutineValue(value any, env map[string]string) any {
 	switch typed := value.(type) {
 	case string:
diff --git a/cli/azd/extensions/azure.ai.routines/internal/cmd/service_target_test.go b/cli/azd/extensions/azure.ai.routines/internal/cmd/service_target_test.go
index 4df169c2cd9..074fa000190 100644
--- a/cli/azd/extensions/azure.ai.routines/internal/cmd/service_target_test.go
+++ b/cli/azd/extensions/azure.ai.routines/internal/cmd/service_target_test.go
@@ -57,3 +57,25 @@ func TestParseRoutineServiceConfig_ConfigFallback(t *testing.T) {
 	require.NoError(t, err)
 	assert.Equal(t, "legacy", body.Description)
 }
+
+func TestExpandRoutineValue(t *testing.T) {
+	t.Parallel()
+
+	serviceConfig := &azdext.ServiceConfig{
+		Environment: map[string]string{"DIGEST_TOPIC": "weekly changes"},
+	}
+	environment, err := (&routineServiceTarget{}).environmentValues(
+		t.Context(),
+		serviceConfig,
+	)
+	require.NoError(t, err)
+	input := map[string]any{
+		"topic":  "${DIGEST_TOPIC}",
+		"secret": "${{connections.search.credentials.key}}",
+	}
+
+	assert.Equal(t, map[string]any{
+		"topic":  "weekly changes",
+		"secret": "${{connections.search.credentials.key}}",
+	}, expandRoutineValue(input, environment))
+}
diff --git a/cli/azd/extensions/azure.ai.routines/schemas/azure.ai.routine.json b/cli/azd/extensions/azure.ai.routines/schemas/azure.ai.routine.json
index 40058c5dfaa..d4f72ec59c7 100644
--- a/cli/azd/extensions/azure.ai.routines/schemas/azure.ai.routine.json
+++ b/cli/azd/extensions/azure.ai.routines/schemas/azure.ai.routine.json
@@ -36,7 +36,7 @@
       "properties": {
         "type": { "type": "string", "description": "Action variant (e.g. invoke_agent_responses_api, invoke_agent_invocations_api)." },
         "agent_name": { "type": "string", "description": "Name of the azure.ai.agent service the routine invokes." },
-        "input": { "description": "Static JSON input sent to the agent when the routine fires. Values may use ${VAR} or ${{...}}." }
+        "input": { "description": "Static JSON input sent to the agent when the routine fires. Values may use ${VAR} declared in the service-level env object or ${{...}} for Foundry server-side resolution." }
       }
     }
   }
diff --git a/cli/azd/extensions/azure.ai.toolboxes/extension.yaml b/cli/azd/extensions/azure.ai.toolboxes/extension.yaml
index 494cbc823d8..84e47842a00 100644
--- a/cli/azd/extensions/azure.ai.toolboxes/extension.yaml
+++ b/cli/azd/extensions/azure.ai.toolboxes/extension.yaml
@@ -17,4 +17,4 @@ tags:
     - toolbox
 usage: azd ai toolbox <command> [options]
 version: 1.0.0-beta.2
-requiredAzdVersion: ">=1.27.0"
+requiredAzdVersion: ">=1.27.1"
diff --git a/cli/azd/extensions/azure.ai.toolboxes/go.mod b/cli/azd/extensions/azure.ai.toolboxes/go.mod
index 83c9963b07a..c6acba62c1a 100644
--- a/cli/azd/extensions/azure.ai.toolboxes/go.mod
+++ b/cli/azd/extensions/azure.ai.toolboxes/go.mod
@@ -2,18 +2,14 @@ module azure.ai.toolboxes
 
 go 1.26.4
 
-// TEMPORARY: local validation against the in-tree azd core for the shared
-// pkg/foundry helpers (the $ref resolver and ${VAR}/${{...}} expander). Remove
-// before merging — the core change must land first, then bump the azd dependency.
-replace github.com/azure/azure-dev/cli/azd => ../../
-
 require (
 	github.com/Azure/azure-sdk-for-go/sdk/azcore v1.20.0
 	github.com/Azure/azure-sdk-for-go/sdk/azidentity v1.13.1
-	github.com/azure/azure-dev/cli/azd v1.25.0
+	github.com/azure/azure-dev/cli/azd v1.27.1
 	github.com/spf13/cobra v1.10.1
 	github.com/stretchr/testify v1.11.1
 	google.golang.org/grpc v1.80.0
+	google.golang.org/protobuf v1.36.11
 	gopkg.in/yaml.v3 v3.0.1
 )
 
@@ -107,5 +103,4 @@ require (
 	golang.org/x/text v0.38.0 // indirect
 	golang.org/x/time v0.9.0 // indirect
 	google.golang.org/genproto/googleapis/rpc v0.0.0-20260401024825-9d38bb4040a9 // indirect
-	google.golang.org/protobuf v1.36.11 // indirect
 )
diff --git a/cli/azd/extensions/azure.ai.toolboxes/go.sum b/cli/azd/extensions/azure.ai.toolboxes/go.sum
index fccf35ac970..3988398043a 100644
--- a/cli/azd/extensions/azure.ai.toolboxes/go.sum
+++ b/cli/azd/extensions/azure.ai.toolboxes/go.sum
@@ -49,6 +49,8 @@ github.com/aymanbagabas/go-udiff v0.2.0 h1:TK0fH4MteXUDspT88n8CKzvK0X9O2xu9yQjWp
 github.com/aymanbagabas/go-udiff v0.2.0/go.mod h1:RE4Ex0qsGkTAJoQdQQCA0uG+nAzJO/pI/QwceO5fgrA=
 github.com/aymerick/douceur v0.2.0 h1:Mv+mAeH1Q+n9Fr+oyamOlAkUNPWPlA8PPGR0QAaYuPk=
 github.com/aymerick/douceur v0.2.0/go.mod h1:wlT5vV2O3h55X9m7iVYN0TBM0NH/MmbLnd30/FjWUq4=
+github.com/azure/azure-dev/cli/azd v1.27.1 h1:0SrTTBDSG9huHfgt6m89EminAErKtpmOi9gQ+b/T5aw=
+github.com/azure/azure-dev/cli/azd v1.27.1/go.mod h1:Ge7QaU9PoJM7i6J0xArDoQCf2tUn6O7OIKkoItxFTA8=
 github.com/bahlo/generic-list-go v0.2.0 h1:5sz/EEAK+ls5wF+NeqDpk5+iNdMDXrh3z3nPnH1Wvgk=
 github.com/bahlo/generic-list-go v0.2.0/go.mod h1:2KvAjgMlE5NNynlg/5iLrrCCZ2+5xWbdbCW3pNTGyYg=
 github.com/benbjohnson/clock v1.3.5 h1:VvXlSJBzZpA/zum6Sj74hxwYI2DIxRWuNIoXAzHZz5o=
diff --git a/cli/azd/extensions/azure.ai.toolboxes/internal/cmd/service_target.go b/cli/azd/extensions/azure.ai.toolboxes/internal/cmd/service_target.go
index 69dd7e27075..67329a5b3d3 100644
--- a/cli/azd/extensions/azure.ai.toolboxes/internal/cmd/service_target.go
+++ b/cli/azd/extensions/azure.ai.toolboxes/internal/cmd/service_target.go
@@ -38,19 +38,25 @@ type toolboxServiceConfig struct {
 // name is the service key. Package and Publish are no-ops because a toolbox has no build
 // artifact.
 type toolboxServiceTarget struct {
-	azdClient     *azdext.AzdClient
-	serviceConfig *azdext.ServiceConfig
-	resolver      connectionResolver
+	azdClient *azdext.AzdClient
+	resolver  connectionResolver
 }
 
 // newToolboxServiceTarget creates the azure.ai.toolbox service-target provider.
-func newToolboxServiceTarget(azdClient *azdext.AzdClient) azdext.ServiceTargetProvider {
-	return &toolboxServiceTarget{azdClient: azdClient, resolver: defaultConnectionResolver{}}
+func newToolboxServiceTarget(
+	azdClient *azdext.AzdClient,
+) azdext.ServiceTargetProvider {
+	return &toolboxServiceTarget{
+		azdClient: azdClient,
+		resolver:  defaultConnectionResolver{},
+	}
 }
 
-// Initialize stores the service configuration; no other setup is required.
-func (p *toolboxServiceTarget) Initialize(ctx context.Context, serviceConfig *azdext.ServiceConfig) error {
-	p.serviceConfig = serviceConfig
+// Initialize requires no setup.
+func (p *toolboxServiceTarget) Initialize(
+	_ context.Context,
+	_ *azdext.ServiceConfig,
+) error {
 	return nil
 }
 
@@ -105,8 +111,8 @@ func (p *toolboxServiceTarget) Publish(
 
 // Deploy upserts the toolbox by creating a new version from the entry's tools. Tool
 // entries that name a `connection` are resolved to their project_connection_id (the
-// `uses:` edge guarantees the connection is reconciled first). ${VAR} references resolve
-// against the azd environment; Foundry ${{...}} expressions pass through untouched.
+// `uses:` edge guarantees the connection is reconciled first). ${VAR}
+// references resolve from the forwarded service environment.
 // Removing the service from azure.yaml stops azd managing the toolbox but does not delete
 // it (use `azd ai toolbox delete`).
 func (p *toolboxServiceTarget) Deploy(
@@ -128,12 +134,16 @@ func (p *toolboxServiceTarget) Deploy(
 	}
 	endpoint := resolved.Endpoint
 
-	env, err := p.currentEnvValues(ctx)
+	environment, err := p.environmentValues(ctx, serviceConfig)
 	if err != nil {
 		return nil, err
 	}
-
-	tools, err := p.buildToolEntries(ctx, endpoint, cfg.Tools, env)
+	tools, err := p.buildToolEntries(
+		ctx,
+		endpoint,
+		cfg.Tools,
+		environment,
+	)
 	if err != nil {
 		return nil, err
 	}
@@ -219,16 +229,27 @@ func parseToolboxServiceConfig(svc *azdext.ServiceConfig) (*toolboxServiceConfig
 	return cfg, nil
 }
 
-// currentEnvValues loads all key-value pairs from the active azd environment, used to
-// resolve ${VAR} references in tool fields at deploy time.
-func (p *toolboxServiceTarget) currentEnvValues(ctx context.Context) (map[string]string, error) {
-	current, err := p.azdClient.Environment().GetCurrent(ctx, &azdext.EmptyRequest{})
+func (p *toolboxServiceTarget) environmentValues(
+	ctx context.Context,
+	serviceConfig *azdext.ServiceConfig,
+) (map[string]string, error) {
+	if environment := serviceConfig.GetEnvironment(); len(environment) > 0 {
+		return environment, nil
+	}
+
+	current, err := p.azdClient.Environment().GetCurrent(
+		ctx,
+		&azdext.EmptyRequest{},
+	)
 	if err != nil {
 		return nil, fmt.Errorf("resolving current azd environment: %w", err)
 	}
-	resp, err := p.azdClient.Environment().GetValues(ctx, &azdext.GetEnvironmentRequest{
-		Name: current.GetEnvironment().GetName(),
-	})
+	resp, err := p.azdClient.Environment().GetValues(
+		ctx,
+		&azdext.GetEnvironmentRequest{
+			Name: current.GetEnvironment().GetName(),
+		},
+	)
 	if err != nil {
 		return nil, fmt.Errorf("loading azd environment values: %w", err)
 	}
@@ -239,9 +260,7 @@ func (p *toolboxServiceTarget) currentEnvValues(ctx context.Context) (map[string
 	return values, nil
 }
 
-// expandToolboxValue recursively expands ${VAR} references in every string within a tool
-// value (maps, slices, scalars) against the azd environment, preserving Foundry
-// server-side ${{...}} expressions.
+// expandToolboxValue expands ${VAR} in nested toolbox values.
 func expandToolboxValue(value any, env map[string]string) any {
 	switch typed := value.(type) {
 	case string:
diff --git a/cli/azd/extensions/azure.ai.toolboxes/internal/cmd/service_target_test.go b/cli/azd/extensions/azure.ai.toolboxes/internal/cmd/service_target_test.go
index 2c08f4c949c..b91db14c782 100644
--- a/cli/azd/extensions/azure.ai.toolboxes/internal/cmd/service_target_test.go
+++ b/cli/azd/extensions/azure.ai.toolboxes/internal/cmd/service_target_test.go
@@ -79,14 +79,26 @@ func TestBuildToolEntries_ResolvesConnectionRef(t *testing.T) {
 func TestExpandToolboxValue(t *testing.T) {
 	t.Parallel()
 
-	env := map[string]string{"MCP_URL": "https://resolved.example.com"}
+	serviceConfig := &azdext.ServiceConfig{
+		Environment: map[string]string{
+			"MCP_URL": "https://resolved.example.com",
+		},
+	}
+	environment, err := (&toolboxServiceTarget{}).environmentValues(
+		t.Context(),
+		serviceConfig,
+	)
+	require.NoError(t, err)
 	in := map[string]any{
 		"type":       "mcp",
 		"server_url": "${MCP_URL}",
 		"headers":    []any{"x-secret: ${{secrets.token}}"},
 	}
 
-	out, ok := expandToolboxValue(in, env).(map[string]any)
+	out, ok := expandToolboxValue(
+		in,
+		environment,
+	).(map[string]any)
 	require.True(t, ok)
 	assert.Equal(t, "https://resolved.example.com", out["server_url"])
 	// Foundry ${{...}} passes through untouched.
diff --git a/cli/azd/extensions/azure.ai.toolboxes/schemas/azure.ai.toolbox.json b/cli/azd/extensions/azure.ai.toolboxes/schemas/azure.ai.toolbox.json
index 46b35dbfd68..807266c82e6 100644
--- a/cli/azd/extensions/azure.ai.toolboxes/schemas/azure.ai.toolbox.json
+++ b/cli/azd/extensions/azure.ai.toolboxes/schemas/azure.ai.toolbox.json
@@ -12,7 +12,7 @@
     },
     "tools": {
       "type": "array",
-      "description": "List of tools in the toolbox.",
+      "description": "List of tools in the toolbox. Values may use ${VAR} declared in the service-level env object.",
       "items": {
         "type": "object",
         "required": ["type"],
diff --git a/cli/azd/extensions/microsoft.foundry/extension.yaml b/cli/azd/extensions/microsoft.foundry/extension.yaml
index ae8597bfe99..4eb57a9bef7 100644
--- a/cli/azd/extensions/microsoft.foundry/extension.yaml
+++ b/cli/azd/extensions/microsoft.foundry/extension.yaml
@@ -6,7 +6,7 @@ tags:
     - ai
     - foundry
 version: 1.0.0-beta.1
-requiredAzdVersion: ">=1.27.0"
+requiredAzdVersion: ">=1.27.1"
 dependencies:
   - id: azure.ai.agents
     version: "~1.0.0-beta.1"

From afc5216599d8790e58025f3fdd619cb8ae86fe21 Mon Sep 17 00:00:00 2001
From: huimiu <miuhui@outlook.com>
Date: Fri, 10 Jul 2026 18:37:20 +0800
Subject: [PATCH 2/4] fix: document Foundry service env migration

---
 cli/azd/extensions/azure.ai.agents/CHANGELOG.md      | 4 ++++
 cli/azd/extensions/azure.ai.connections/CHANGELOG.md | 6 ++++++
 cli/azd/extensions/azure.ai.routines/CHANGELOG.md    | 6 ++++++
 cli/azd/extensions/azure.ai.toolboxes/CHANGELOG.md   | 6 ++++++
 cli/azd/extensions/microsoft.foundry/CHANGELOG.md    | 6 ++++++
 5 files changed, 28 insertions(+)

diff --git a/cli/azd/extensions/azure.ai.agents/CHANGELOG.md b/cli/azd/extensions/azure.ai.agents/CHANGELOG.md
index 941dd97a5f9..832b09da97f 100644
--- a/cli/azd/extensions/azure.ai.agents/CHANGELOG.md
+++ b/cli/azd/extensions/azure.ai.agents/CHANGELOG.md
@@ -2,6 +2,10 @@
 
 ## 1.0.0-beta.6 (Unreleased)
 
+### Bugs Fixed
+
+- [[#9079]](https://github.com/Azure/azure-dev/pull/9079) Store hosted-agent runtime variables in the standard service-level `env` object and read the expanded values forwarded by azd core. `azd ai agent init` no longer writes the unsupported inline `environmentVariables` shape; legacy inline and on-disk agent definitions remain readable.
+
 ### Other Changes
 
 - [[#9049]](https://github.com/Azure/azure-dev/pull/9049) Switch the `invocations_ws` agent endpoint from the preview dispatcher form to the GA path-based route. `azd deploy` now registers `AGENT_{KEY}_INVOCATIONS_WS_ENDPOINT` (and `azd ai agent show` displays `Endpoint (invocations_ws)`) as `wss://<account>.services.ai.azure.com/api/projects/<project>/agents/<agent>/endpoint/protocols/invocations_ws?api-version=v1`, carrying the project and agent as path segments to mirror the HTTP `invocations` route. The previous form embedded them as `project_name`/`agent_name` query parameters on a single literal `/api/projects/agents/...` path.
diff --git a/cli/azd/extensions/azure.ai.connections/CHANGELOG.md b/cli/azd/extensions/azure.ai.connections/CHANGELOG.md
index 5ecd9a65ff1..c617849f196 100644
--- a/cli/azd/extensions/azure.ai.connections/CHANGELOG.md
+++ b/cli/azd/extensions/azure.ai.connections/CHANGELOG.md
@@ -1,5 +1,11 @@
 # Release History
 
+## 1.0.0-beta.3 (Unreleased)
+
+### Bugs Fixed
+
+- [[#9079]](https://github.com/Azure/azure-dev/pull/9079) Resolve `${VAR}` references from the service-level `env` object forwarded by azd core. Existing services without `env` keep falling back to the active azd environment.
+
 ## 1.0.0-beta.2 (2026-07-09)
 
 ### Bugs Fixed
diff --git a/cli/azd/extensions/azure.ai.routines/CHANGELOG.md b/cli/azd/extensions/azure.ai.routines/CHANGELOG.md
index bcfd3a84bf3..2cb28a4f83f 100644
--- a/cli/azd/extensions/azure.ai.routines/CHANGELOG.md
+++ b/cli/azd/extensions/azure.ai.routines/CHANGELOG.md
@@ -1,5 +1,11 @@
 # Release History
 
+## 1.0.0-beta.3 (Unreleased)
+
+### Bugs Fixed
+
+- [[#9079]](https://github.com/Azure/azure-dev/pull/9079) Resolve routine input `${VAR}` references from the service-level `env` object forwarded by azd core. Existing services without `env` keep falling back to the active azd environment.
+
 ## 1.0.0-beta.2 (2026-07-09)
 
 ### Bugs Fixed
diff --git a/cli/azd/extensions/azure.ai.toolboxes/CHANGELOG.md b/cli/azd/extensions/azure.ai.toolboxes/CHANGELOG.md
index f6134911adc..70136f9c987 100644
--- a/cli/azd/extensions/azure.ai.toolboxes/CHANGELOG.md
+++ b/cli/azd/extensions/azure.ai.toolboxes/CHANGELOG.md
@@ -1,5 +1,11 @@
 # Release History
 
+## 1.0.0-beta.3 (Unreleased)
+
+### Bugs Fixed
+
+- [[#9079]](https://github.com/Azure/azure-dev/pull/9079) Resolve toolbox `${VAR}` references from the service-level `env` object forwarded by azd core. Existing services without `env` keep falling back to the active azd environment.
+
 ## 1.0.0-beta.2 (2026-07-09)
 
 ### Other Changes
diff --git a/cli/azd/extensions/microsoft.foundry/CHANGELOG.md b/cli/azd/extensions/microsoft.foundry/CHANGELOG.md
index 8c4fe543015..0bea9898bb5 100644
--- a/cli/azd/extensions/microsoft.foundry/CHANGELOG.md
+++ b/cli/azd/extensions/microsoft.foundry/CHANGELOG.md
@@ -1,5 +1,11 @@
 # Release History
 
+## 1.0.0-beta.2 (Unreleased)
+
+### Other Changes
+
+- [[#9079]](https://github.com/Azure/azure-dev/pull/9079) Require azd 1.27.1 so bundled Foundry service targets receive service-level environment values.
+
 ## 1.0.0-beta.1 (2026-06-30)
 
 ### Features Added

From b634164fc93bf860cb4d0c3eb4acf30dd954791e Mon Sep 17 00:00:00 2001
From: "copilot-swe-agent[bot]" <198982749+Copilot@users.noreply.github.com>
Date: Tue, 14 Jul 2026 09:59:15 +0000
Subject: [PATCH 3/4] fix: resolve merge conflicts in azure.ai.connections
 service target

Co-authored-by: huimiu <107838226+huimiu@users.noreply.github.com>
---
 .../internal/cmd/service_target.go            | 197 +-----------------
 .../internal/cmd/service_target_test.go       |  68 ------
 2 files changed, 6 insertions(+), 259 deletions(-)

diff --git a/cli/azd/extensions/azure.ai.connections/internal/cmd/service_target.go b/cli/azd/extensions/azure.ai.connections/internal/cmd/service_target.go
index 214e760835a..3f7b4b59e14 100644
--- a/cli/azd/extensions/azure.ai.connections/internal/cmd/service_target.go
+++ b/cli/azd/extensions/azure.ai.connections/internal/cmd/service_target.go
@@ -21,21 +21,18 @@ var _ azdext.ServiceTargetProvider = (*connectionServiceTarget)(nil)
 // connection entry in the deploy graph. All lifecycle methods are no-ops; see
 // Deploy for why.
 type connectionServiceTarget struct {
-	azdClient *azdext.AzdClient
+	azdClient     *azdext.AzdClient
+	serviceConfig *azdext.ServiceConfig
 }
 
 // newConnectionServiceTarget creates the azure.ai.connection service-target provider.
-func newConnectionServiceTarget(
-	azdClient *azdext.AzdClient,
-) azdext.ServiceTargetProvider {
+func newConnectionServiceTarget(azdClient *azdext.AzdClient) azdext.ServiceTargetProvider {
 	return &connectionServiceTarget{azdClient: azdClient}
 }
 
-// Initialize requires no setup.
-func (p *connectionServiceTarget) Initialize(
-	_ context.Context,
-	_ *azdext.ServiceConfig,
-) error {
+// Initialize stores the service configuration; no other setup is required.
+func (p *connectionServiceTarget) Initialize(ctx context.Context, serviceConfig *azdext.ServiceConfig) error {
+	p.serviceConfig = serviceConfig
 	return nil
 }
 
@@ -87,13 +84,6 @@ func (p *connectionServiceTarget) Publish(
 	return &azdext.ServicePublishResult{}, nil
 }
 
-<<<<<<< HEAD
-// Deploy upserts the connection on its project via an idempotent ARM CreateOrUpdate.
-// ${VAR} references resolve from the forwarded service environment.
-// Foundry server-side ${{...}} expressions pass through untouched.
-// Removing the service from azure.yaml stops azd managing the connection but does not
-// delete it (use `azd ai connection delete`).
-=======
 // Deploy is a no-op. Connections declared as host: azure.ai.connection
 // services are created at provision time by the microsoft.foundry provider
 // (for both greenfield and brownfield projects), so creating them again here
@@ -104,7 +94,6 @@ func (p *connectionServiceTarget) Publish(
 // `uses:` (toolboxes/agents that depend on it). Removing a connection from
 // azure.yaml stops azd managing it but does not delete it (use
 // `azd ai connection delete`).
->>>>>>> origin/main
 func (p *connectionServiceTarget) Deploy(
 	ctx context.Context,
 	serviceConfig *azdext.ServiceConfig,
@@ -112,183 +101,9 @@ func (p *connectionServiceTarget) Deploy(
 	targetResource *azdext.TargetResource,
 	progress azdext.ProgressReporter,
 ) (*azdext.ServiceDeployResult, error) {
-<<<<<<< HEAD
-	cfg, err := parseConnectionServiceConfig(serviceConfig)
-	if err != nil {
-		return nil, err
-	}
-	name := serviceConfig.GetName()
-
-	env, err := p.environmentValues(ctx, serviceConfig)
-	if err != nil {
-		return nil, err
-	}
-	expand := func(value string) string { return resolveConnectionEnv(value, env) }
-
-	kebabAuth := normalizeAuthType(strings.TrimSpace(cfg.AuthType))
-	// Identity-based and OAuth2 connections are provisioned by `connection create`
-	// (init/provision), not at deploy time. buildConnectionBody can't build their
-	// bodies, so upserting here would fail azd deploy. Skip them; the api-key,
-	// custom-keys, and none types are still upserted to stay current.
-	if !supportsDeployUpsert(kebabAuth) {
-		if progress != nil {
-			progress(fmt.Sprintf("Connection %q uses %s auth provisioned elsewhere; skipping deploy upsert", name, kebabAuth))
-		}
-		return &azdext.ServiceDeployResult{}, nil
-	}
-	key, customKeys := connectionCredentialArgs(kebabAuth, cfg.Credentials, expand)
-	body, err := buildConnectionBody(
-		cfg.Category, expand(cfg.Target), kebabAuth, key, customKeys,
-		connectionMetadataPairs(cfg.Metadata, expand), "", "",
-	)
-	if err != nil {
-		return nil, err
-	}
-
-=======
->>>>>>> origin/main
 	if progress != nil {
 		progress(fmt.Sprintf(
 			"Connection %q is provisioned by infrastructure; nothing to deploy", serviceConfig.GetName()))
 	}
 	return &azdext.ServiceDeployResult{}, nil
 }
-<<<<<<< HEAD
-
-// parseConnectionServiceConfig reads the service-level (inline) connection properties,
-// falling back to the deprecated config: shape for azure.yaml files written before the
-// per-resource service split.
-func parseConnectionServiceConfig(svc *azdext.ServiceConfig) (*connectionServiceConfig, error) {
-	props := svc.GetAdditionalProperties()
-	if props == nil || len(props.GetFields()) == 0 {
-		props = svc.GetConfig()
-	}
-	cfg := &connectionServiceConfig{}
-	if props == nil {
-		return cfg, nil
-	}
-	b, err := json.Marshal(props.AsMap())
-	if err != nil {
-		return nil, fmt.Errorf("encoding connection service %q config: %w", svc.GetName(), err)
-	}
-	if err := json.Unmarshal(b, cfg); err != nil {
-		return nil, fmt.Errorf("parsing connection service %q config: %w", svc.GetName(), err)
-	}
-	return cfg, nil
-}
-
-func (p *connectionServiceTarget) environmentValues(
-	ctx context.Context,
-	serviceConfig *azdext.ServiceConfig,
-) (map[string]string, error) {
-	if environment := serviceConfig.GetEnvironment(); len(environment) > 0 {
-		return environment, nil
-	}
-
-	current, err := p.azdClient.Environment().GetCurrent(
-		ctx,
-		&azdext.EmptyRequest{},
-	)
-	if err != nil {
-		return nil, fmt.Errorf("resolving current azd environment: %w", err)
-	}
-	resp, err := p.azdClient.Environment().GetValues(
-		ctx,
-		&azdext.GetEnvironmentRequest{
-			Name: current.GetEnvironment().GetName(),
-		},
-	)
-	if err != nil {
-		return nil, fmt.Errorf("loading azd environment values: %w", err)
-	}
-	values := make(map[string]string, len(resp.GetKeyValues()))
-	for _, kv := range resp.GetKeyValues() {
-		values[kv.GetKey()] = kv.GetValue()
-	}
-	return values, nil
-}
-
-// resolveConnectionEnv expands ${VAR} from the service environment.
-func resolveConnectionEnv(value string, env map[string]string) string {
-	resolved, err := foundry.ExpandEnv(value, func(name string) string { return env[name] })
-	if err != nil {
-		return value
-	}
-	return resolved
-}
-
-// supportsDeployUpsert reports whether buildConnectionBody can build a body for
-// authType at deploy time. Identity-based and OAuth2 types are provisioned by
-// `connection create`, so they are skipped during deploy.
-func supportsDeployUpsert(authType string) bool {
-	switch authType {
-	case "api-key", "custom-keys", "none", "":
-		return true
-	default:
-		return false
-	}
-}
-
-// connectionCredentialArgs maps the service entry's credentials map to the key /
-// custom-keys arguments buildConnectionBody expects, expanding ${VAR} per value. Only
-// the auth types buildConnectionBody supports inline (api-key, custom-keys, none) are
-// mapped here; other auth types surface buildConnectionBody's own validation error.
-func connectionCredentialArgs(
-	kebabAuth string,
-	credentials map[string]any,
-	expand func(string) string,
-) (key string, customKeys []string) {
-	switch kebabAuth {
-	case "api-key":
-		key = expand(stringFromAny(credentials["key"]))
-	case "custom-keys":
-		for _, k := range sortedKeys(credentials) {
-			customKeys = append(customKeys, fmt.Sprintf("%s=%s", k, expand(stringFromAny(credentials[k]))))
-		}
-	}
-	return key, customKeys
-}
-
-// connectionMetadataPairs renders the metadata map as sorted key=value pairs with ${VAR}
-// expanded, matching the []string shape buildConnectionBody consumes.
-func connectionMetadataPairs(metadata map[string]string, expand func(string) string) []string {
-	if len(metadata) == 0 {
-		return nil
-	}
-	keys := make([]string, 0, len(metadata))
-	for k := range metadata {
-		keys = append(keys, k)
-	}
-	sort.Strings(keys)
-	pairs := make([]string, 0, len(metadata))
-	for _, k := range keys {
-		pairs = append(pairs, fmt.Sprintf("%s=%s", k, expand(metadata[k])))
-	}
-	return pairs
-}
-
-// sortedKeys returns the keys of m in sorted order so generated credential pairs are
-// deterministic across deploys.
-func sortedKeys(m map[string]any) []string {
-	keys := make([]string, 0, len(m))
-	for k := range m {
-		keys = append(keys, k)
-	}
-	sort.Strings(keys)
-	return keys
-}
-
-// stringFromAny renders a credential or metadata value as a string. Non-string scalars
-// are formatted with their default representation; nil becomes empty.
-func stringFromAny(v any) string {
-	switch typed := v.(type) {
-	case nil:
-		return ""
-	case string:
-		return typed
-	default:
-		return fmt.Sprintf("%v", typed)
-	}
-}
-=======
->>>>>>> origin/main
diff --git a/cli/azd/extensions/azure.ai.connections/internal/cmd/service_target_test.go b/cli/azd/extensions/azure.ai.connections/internal/cmd/service_target_test.go
index 0b9616c52c4..f644710799e 100644
--- a/cli/azd/extensions/azure.ai.connections/internal/cmd/service_target_test.go
+++ b/cli/azd/extensions/azure.ai.connections/internal/cmd/service_target_test.go
@@ -52,73 +52,5 @@ func TestPackagePublish_AreNoOps(t *testing.T) {
 
 	endpoints, err := target.Endpoints(t.Context(), svc, nil)
 	require.NoError(t, err)
-<<<<<<< HEAD
-	assert.Equal(t, "CustomKeys", cfg.Category)
-	assert.Equal(t, "CustomKeys", cfg.AuthType)
-}
-
-func TestConnectionCredentialArgs(t *testing.T) {
-	t.Parallel()
-
-	identity := func(s string) string { return s }
-
-	t.Run("api-key reads the key credential", func(t *testing.T) {
-		t.Parallel()
-		key, customKeys := connectionCredentialArgs("api-key", map[string]any{"key": "secret"}, identity)
-		assert.Equal(t, "secret", key)
-		assert.Empty(t, customKeys)
-	})
-
-	t.Run("custom-keys renders sorted key=value pairs", func(t *testing.T) {
-		t.Parallel()
-		key, customKeys := connectionCredentialArgs(
-			"custom-keys",
-			map[string]any{"b-token": "2", "a-token": "1"},
-			identity,
-		)
-		assert.Empty(t, key)
-		assert.Equal(t, []string{"a-token=1", "b-token=2"}, customKeys)
-	})
-}
-
-func TestResolveConnectionEnv(t *testing.T) {
-	t.Parallel()
-
-	serviceConfig := &azdext.ServiceConfig{
-		Environment: map[string]string{"SEARCH_KEY": "resolved-secret"},
-	}
-	environment, err := (&connectionServiceTarget{}).environmentValues(
-		t.Context(),
-		serviceConfig,
-	)
-	require.NoError(t, err)
-
-	// Foundry server-side expressions pass through untouched.
-	assert.Equal(t,
-		"resolved-secret",
-		resolveConnectionEnv(
-			"${SEARCH_KEY}",
-			environment,
-		),
-	)
-	assert.Equal(t,
-		"${{connections.x.credentials.key}}",
-		resolveConnectionEnv(
-			"${{connections.x.credentials.key}}",
-			environment,
-		),
-	)
-}
-
-func TestConnectionMetadataPairs(t *testing.T) {
-	t.Parallel()
-
-	pairs := connectionMetadataPairs(
-		map[string]string{"type": "gateway", "team": "search"},
-		func(s string) string { return s },
-	)
-	assert.Equal(t, []string{"team=search", "type=gateway"}, pairs)
-=======
 	assert.Nil(t, endpoints)
->>>>>>> origin/main
 }

From f6940b13cf63cd698203fd3a379da2a74e255ed9 Mon Sep 17 00:00:00 2001
From: huimiu <miuhui@outlook.com>
Date: Tue, 14 Jul 2026 18:33:26 +0800
Subject: [PATCH 4/4] fix: preserve Foundry service environment migration

---
 .../internal/project/agent_definition.go           |  9 ++++++++-
 .../internal/project/agent_definition_test.go      | 14 ++++++++++++--
 cli/azd/extensions/azure.ai.connections/go.mod     |  2 +-
 3 files changed, 21 insertions(+), 4 deletions(-)

diff --git a/cli/azd/extensions/azure.ai.agents/internal/project/agent_definition.go b/cli/azd/extensions/azure.ai.agents/internal/project/agent_definition.go
index 74ffe9324eb..dad7a2c3d9a 100644
--- a/cli/azd/extensions/azure.ai.agents/internal/project/agent_definition.go
+++ b/cli/azd/extensions/azure.ai.agents/internal/project/agent_definition.go
@@ -126,7 +126,14 @@ func (d AgentDefinitionInline) toContainerAgent(
 ) agent_yaml.ContainerAgent {
 	environmentVariables := d.EnvironmentVariables
 	if len(environment) > 0 {
-		environmentVariables = environmentVariablesFromMap(environment)
+		legacyEnvironment := AgentEnvironment(agent_yaml.ContainerAgent{
+			EnvironmentVariables: d.EnvironmentVariables,
+		})
+		if legacyEnvironment == nil {
+			legacyEnvironment = map[string]string{}
+		}
+		maps.Copy(legacyEnvironment, environment)
+		environmentVariables = environmentVariablesFromMap(legacyEnvironment)
 	}
 
 	ca := agent_yaml.ContainerAgent{
diff --git a/cli/azd/extensions/azure.ai.agents/internal/project/agent_definition_test.go b/cli/azd/extensions/azure.ai.agents/internal/project/agent_definition_test.go
index 376b2a8d4ca..27c2f145ed0 100644
--- a/cli/azd/extensions/azure.ai.agents/internal/project/agent_definition_test.go
+++ b/cli/azd/extensions/azure.ai.agents/internal/project/agent_definition_test.go
@@ -125,14 +125,22 @@ func TestAgentDefinitionFromService_LegacyEnvironment(t *testing.T) {
 			"name":  "LEGACY_KEY",
 			"value": "${LEGACY_KEY}",
 		},
+		map[string]any{
+			"name":  "SHARED_KEY",
+			"value": "legacy",
+		},
 	})
 	require.NoError(t, err)
 	props.Fields["environmentVariables"] = legacyEnvironment
 
 	svc := &azdext.ServiceConfig{
-		Name:   "basic-agent",
-		Host:   "azure.ai.agent",
+		Name: "basic-agent",
+		Host: "azure.ai.agent",
 		Config: props,
+		Environment: map[string]string{
+			"NEW_KEY":    "new",
+			"SHARED_KEY": "service",
+		},
 	}
 	got, _, found, source, err := AgentDefinitionFromService(svc)
 	require.NoError(t, err)
@@ -140,6 +148,8 @@ func TestAgentDefinitionFromService_LegacyEnvironment(t *testing.T) {
 	require.Equal(t, AgentDefinitionSourceLegacyConfig, source)
 	require.Equal(t, map[string]string{
 		"LEGACY_KEY": "${LEGACY_KEY}",
+		"NEW_KEY":    "new",
+		"SHARED_KEY": "service",
 	}, AgentEnvironment(got))
 }
 
diff --git a/cli/azd/extensions/azure.ai.connections/go.mod b/cli/azd/extensions/azure.ai.connections/go.mod
index 0658ddc7fac..26fffda7718 100644
--- a/cli/azd/extensions/azure.ai.connections/go.mod
+++ b/cli/azd/extensions/azure.ai.connections/go.mod
@@ -11,7 +11,6 @@ require (
 	github.com/spf13/cobra v1.10.1
 	github.com/stretchr/testify v1.11.1
 	google.golang.org/grpc v1.80.0
-	google.golang.org/protobuf v1.36.11
 )
 
 require (
@@ -102,5 +101,6 @@ require (
 	golang.org/x/text v0.38.0 // indirect
 	golang.org/x/time v0.9.0 // indirect
 	google.golang.org/genproto/googleapis/rpc v0.0.0-20260401024825-9d38bb4040a9 // indirect
+	google.golang.org/protobuf v1.36.11 // indirect
 	gopkg.in/yaml.v3 v3.0.1 // indirect
 )