diff --git a/src/extension/debugger/configuration/resolvers/helper.ts b/src/extension/debugger/configuration/resolvers/helper.ts
index 6791bded..8e84d922 100644
--- a/src/extension/debugger/configuration/resolvers/helper.ts
+++ b/src/extension/debugger/configuration/resolvers/helper.ts
@@ -19,7 +19,9 @@ export async function getDebugEnvironmentVariables(args: LaunchRequestArguments)
         args.env && Object.keys(args.env).length > 0
             ? ({ ...args.env } as Record<string, string>)
             : ({} as Record<string, string>);
-    const envFileVars = await envParser.parseFile(args.envFile, debugLaunchEnvVars);
+    // Merge process.env with debugLaunchEnvVars for variable substitution in .env file
+    const baseVars = { ...process.env, ...debugLaunchEnvVars };
+    const envFileVars = await envParser.parseFile(args.envFile, baseVars);
     const env = envFileVars ? { ...envFileVars } : {};
 
     // "overwrite: true" to ensure that debug-configuration env variable values
diff --git a/src/test/unittest/configuration/resolvers/helper.environment.unit.test.ts b/src/test/unittest/configuration/resolvers/helper.environment.unit.test.ts
new file mode 100644
index 00000000..d3c010ba
--- /dev/null
+++ b/src/test/unittest/configuration/resolvers/helper.environment.unit.test.ts
@@ -0,0 +1,165 @@
+// Copyright (c) Microsoft Corporation. All rights reserved.
+// Licensed under the MIT License.
+
+'use strict';
+
+import { expect } from 'chai';
+import * as sinon from 'sinon';
+import * as envParser from '../../../../extension/common/variables/environment';
+import { getDebugEnvironmentVariables } from '../../../../extension/debugger/configuration/resolvers/helper';
+import { LaunchRequestArguments } from '../../../../extension/types';
+
+suite('Debugging - Environment Variable Substitution', () => {
+    let parseFileStub: sinon.SinonStub;
+
+    setup(() => {
+        parseFileStub = sinon.stub(envParser, 'parseFile');
+        sinon.stub(envParser, 'mergeVariables');
+        sinon.stub(envParser, 'appendPath');
+        sinon.stub(envParser, 'appendPythonPath');
+    });
+
+    teardown(() => {
+        sinon.restore();
+    });
+
+    test('Environment variables from process.env should be available for substitution in .env file', async () => {
+        // Arrange
+        const args: LaunchRequestArguments = {
+            name: 'Test',
+            type: 'debugpy',
+            request: 'launch',
+            envFile: '/path/to/.env',
+            env: {
+                CUSTOM_VAR: 'custom_value',
+            },
+        };
+
+        // Set up process.env
+        const originalPath = process.env.PATH;
+        process.env.PATH = '/usr/bin:/usr/local/bin';
+
+        parseFileStub.resolves({
+            EXPANDED_PATH: '${PATH}:/my/custom/path',
+        });
+
+        // Act
+        await getDebugEnvironmentVariables(args);
+
+        // Assert
+        // Verify that parseFile was called with merged environment variables
+        expect(parseFileStub.calledOnce).to.be.true;
+        const [envFilePath, baseVars] = parseFileStub.firstCall.args;
+        expect(envFilePath).to.equal('/path/to/.env');
+        expect(baseVars).to.have.property('PATH', '/usr/bin:/usr/local/bin');
+        expect(baseVars).to.have.property('CUSTOM_VAR', 'custom_value');
+
+        // Restore process.env
+        if (originalPath !== undefined) {
+            process.env.PATH = originalPath;
+        }
+    });
+
+    test('Debug launch env vars should override process.env during substitution', async () => {
+        // Arrange
+        const args: LaunchRequestArguments = {
+            name: 'Test',
+            type: 'debugpy',
+            request: 'launch',
+            envFile: '/path/to/.env',
+            env: {
+                PATH: '/custom/path',
+                MY_VAR: 'my_value',
+            },
+        };
+
+        // Set up process.env
+        const originalPath = process.env.PATH;
+        process.env.PATH = '/usr/bin:/usr/local/bin';
+        process.env.MY_VAR = 'system_value';
+
+        parseFileStub.resolves({});
+
+        // Act
+        await getDebugEnvironmentVariables(args);
+
+        // Assert
+        expect(parseFileStub.calledOnce).to.be.true;
+        const [, baseVars] = parseFileStub.firstCall.args;
+        // Debug launch vars should override process.env
+        expect(baseVars).to.have.property('PATH', '/custom/path');
+        expect(baseVars).to.have.property('MY_VAR', 'my_value');
+
+        // Restore process.env
+        if (originalPath !== undefined) {
+            process.env.PATH = originalPath;
+        }
+        delete process.env.MY_VAR;
+    });
+
+    test('All process.env variables should be available for substitution', async () => {
+        // Arrange
+        const args: LaunchRequestArguments = {
+            name: 'Test',
+            type: 'debugpy',
+            request: 'launch',
+            envFile: '/path/to/.env',
+            env: {},
+        };
+
+        // Set up process.env
+        const originalEnv = { ...process.env };
+        process.env.TEST_VAR_1 = 'value1';
+        process.env.TEST_VAR_2 = 'value2';
+        process.env.PATH = '/test/path';
+
+        parseFileStub.resolves({});
+
+        // Act
+        await getDebugEnvironmentVariables(args);
+
+        // Assert
+        expect(parseFileStub.calledOnce).to.be.true;
+        const [, baseVars] = parseFileStub.firstCall.args;
+        expect(baseVars).to.have.property('TEST_VAR_1', 'value1');
+        expect(baseVars).to.have.property('TEST_VAR_2', 'value2');
+        expect(baseVars).to.have.property('PATH', '/test/path');
+
+        // Restore process.env
+        Object.keys(process.env).forEach((key) => {
+            if (!(key in originalEnv)) {
+                delete process.env[key];
+            }
+        });
+        Object.assign(process.env, originalEnv);
+    });
+
+    test('Empty env in launch config should still provide process.env for substitution', async () => {
+        // Arrange
+        const args: LaunchRequestArguments = {
+            name: 'Test',
+            type: 'debugpy',
+            request: 'launch',
+            envFile: '/path/to/.env',
+            // No env property
+        };
+
+        const originalPath = process.env.PATH;
+        process.env.PATH = '/usr/bin';
+
+        parseFileStub.resolves({});
+
+        // Act
+        await getDebugEnvironmentVariables(args);
+
+        // Assert
+        expect(parseFileStub.calledOnce).to.be.true;
+        const [, baseVars] = parseFileStub.firstCall.args;
+        expect(baseVars).to.have.property('PATH', '/usr/bin');
+
+        // Restore
+        if (originalPath !== undefined) {
+            process.env.PATH = originalPath;
+        }
+    });
+});