diff --git a/src/core/vscode-workspace.ts b/src/core/vscode-workspace.ts
index a68098d..2571afe 100644
--- a/src/core/vscode-workspace.ts
+++ b/src/core/vscode-workspace.ts
@@ -32,6 +32,21 @@ const DEFAULT_SETTINGS: Record<string, unknown> = {
  */
 export type PathPlaceholderMap = Map<string, string>;
 
+function normalizeWorkspacePath(path: string): string {
+  return path.replace(/\\/g, '/');
+}
+
+function resolveFolderAbsolutePath(workspacePath: string, folderPath: string): string {
+  return (isAbsolute(folderPath)
+    ? folderPath
+    : resolve(workspacePath, folderPath)
+  ).replace(/\\/g, '/');
+}
+
+function resolveFolderDisplayPath(folderPath: string): string {
+  return normalizeWorkspacePath(folderPath);
+}
+
 /**
  * Build a placeholder map from repositories using path as the lookup key.
  *
@@ -127,8 +142,8 @@ export function generateVscodeWorkspace(
 
   // 1. Repository folders (from workspace.yaml)
   for (const repo of repositories) {
-    const absolutePath = resolve(workspacePath, repo.path).replace(/\\/g, '/');
-    const entry: WorkspaceFolder = { path: absolutePath };
+    const absolutePath = resolveFolderAbsolutePath(workspacePath, repo.path);
+    const entry: WorkspaceFolder = { path: resolveFolderDisplayPath(repo.path) };
     if (repo.name) entry.name = repo.name;
     folders.push(entry);
     seenPaths.add(absolutePath);
@@ -138,11 +153,9 @@ export function generateVscodeWorkspace(
   if (resolvedTemplate && Array.isArray(resolvedTemplate.folders)) {
     for (const folder of resolvedTemplate.folders as WorkspaceFolder[]) {
       const rawPath = folder.path as string;
-      const normalizedPath = (typeof rawPath === 'string' && !isAbsolute(rawPath)
-        ? resolve(workspacePath, rawPath)
-        : rawPath).replace(/\\/g, '/');
+      const normalizedPath = resolveFolderAbsolutePath(workspacePath, rawPath);
       if (!seenPaths.has(normalizedPath)) {
-        const entry: WorkspaceFolder = { path: normalizedPath };
+        const entry: WorkspaceFolder = { path: resolveFolderDisplayPath(rawPath) };
         if (folder.name) entry.name = folder.name;
         folders.push(entry);
         seenPaths.add(normalizedPath);
diff --git a/tests/e2e/vscode-workspace-reconcile.test.ts b/tests/e2e/vscode-workspace-reconcile.test.ts
index d260204..5ffcce2 100644
--- a/tests/e2e/vscode-workspace-reconcile.test.ts
+++ b/tests/e2e/vscode-workspace-reconcile.test.ts
@@ -19,7 +19,7 @@ describe('vscode workspace folder reconciliation e2e', () => {
   });
 
   test('removes repo from workspace.yaml when folder removed from .code-workspace', async () => {
-    const repoBPath = resolve(testDir, '../repoB').replace(/\\/g, '/');
+    const repoBPath = '../repoB';
 
     writeFileSync(
       join(testDir, '.allagents', 'workspace.yaml'),
diff --git a/tests/e2e/vscode-workspace-setup.test.ts b/tests/e2e/vscode-workspace-setup.test.ts
index f6f4fc6..1aa53d8 100644
--- a/tests/e2e/vscode-workspace-setup.test.ts
+++ b/tests/e2e/vscode-workspace-setup.test.ts
@@ -35,6 +35,7 @@ clients:
     const content = JSON.parse(readFileSync(expectedPath, 'utf-8'));
     expect(content.folders).toHaveLength(2);
     expect(content.folders[0].path).toBe('.');
+    expect(content.folders[1].path).toBe('../myrepo');
     expect(content.settings).toEqual({ 'chat.agent.maxRequests': 999 });
   });
 
diff --git a/tests/unit/cli/workspace-setup.test.ts b/tests/unit/cli/workspace-setup.test.ts
index 75e508b..67d5491 100644
--- a/tests/unit/cli/workspace-setup.test.ts
+++ b/tests/unit/cli/workspace-setup.test.ts
@@ -39,11 +39,10 @@ clients:
 
     const folders = result.folders as Array<{ path: string }>;
     expect(folders[0].path).toBe('.');
-    // On Windows paths are absolute (C:\...) not starting with /
-    // Just verify they are not relative (don't start with . or ..)
-    for (const folder of folders.slice(1)) {
-      expect(folder.path.startsWith('.')).toBe(false);
-    }
+    expect(folders.slice(1)).toEqual([
+      { path: '../backend' },
+      { path: '../frontend' },
+    ]);
 
     expect(result.settings).toEqual({ 'chat.agent.maxRequests': 999 });
   });
diff --git a/tests/unit/core/vscode-workspace.test.ts b/tests/unit/core/vscode-workspace.test.ts
index c6e83fd..9bf4c9c 100644
--- a/tests/unit/core/vscode-workspace.test.ts
+++ b/tests/unit/core/vscode-workspace.test.ts
@@ -14,7 +14,7 @@ import {
 const testBase = join(tmpdir(), 'allagents-test');
 
 describe('generateVscodeWorkspace', () => {
-  test('generates workspace with repository folders resolved to absolute paths', () => {
+  test('generates workspace with repository folders preserving relative paths from workspace.yaml', () => {
     const workspacePath = join(testBase, 'myapp');
     const result = generateVscodeWorkspace({
       workspacePath,
@@ -27,8 +27,8 @@ describe('generateVscodeWorkspace', () => {
 
     expect(result.folders).toEqual([
       { path: '.' },
-      { path: resolve(workspacePath, '../backend').replace(/\\/g, '/') },
-      { path: resolve(workspacePath, '../frontend').replace(/\\/g, '/') },
+      { path: '../backend' },
+      { path: '../frontend' },
     ]);
   });
 
@@ -45,8 +45,8 @@ describe('generateVscodeWorkspace', () => {
 
     expect(result.folders).toEqual([
       { path: '.' },
-      { path: resolve(workspacePath, '../backend').replace(/\\/g, '/'), name: 'API Server' },
-      { path: resolve(workspacePath, '../frontend').replace(/\\/g, '/') },
+      { path: '../backend', name: 'API Server' },
+      { path: '../frontend' },
     ]);
   });
 
@@ -85,8 +85,8 @@ describe('generateVscodeWorkspace', () => {
     // extra is not a duplicate, so it's kept with its name
     expect(result.folders).toEqual([
       { path: '.' },
-      { path: resolve(workspacePath, '../backend').replace(/\\/g, '/') },
-      { path: sharedPath },
+      { path: '../backend' },
+      { path: '../shared' },
       { path: extraPath, name: 'ExtraLib' },
     ]);
   });