diff --git a/frontend/__tests__/components/features/conversation-panel/system-message-modal/tool-item.test.tsx b/frontend/__tests__/components/features/conversation-panel/system-message-modal/tool-item.test.tsx
new file mode 100644
index 0000000000..15fcef2b5f
--- /dev/null
+++ b/frontend/__tests__/components/features/conversation-panel/system-message-modal/tool-item.test.tsx
@@ -0,0 +1,551 @@
+import { screen } from "@testing-library/react";
+import userEvent from "@testing-library/user-event";
+import { afterEach, describe, expect, it, vi } from "vitest";
+import { renderWithProviders } from "test-utils";
+import { ToolItem } from "#/components/features/conversation-panel/system-message-modal/tool-item";
+import type { ChatCompletionToolParam } from "#/types/v1/core";
+
+describe("ToolItem", () => {
+  const user = userEvent.setup();
+  const onToggleMock = vi.fn();
+
+  afterEach(() => {
+    vi.clearAllMocks();
+  });
+
+  describe("Name/Title Extraction", () => {
+    it("should display name from V0 format function.name", () => {
+      // Arrange
+      const v0Tool: ChatCompletionToolParam = {
+        type: "function",
+        function: {
+          name: "test_function",
+          description: "Test description",
+          parameters: {},
+        },
+      };
+
+      // Act
+      renderWithProviders(
+        <ToolItem
+          tool={v0Tool}
+          index={0}
+          isExpanded={false}
+          onToggle={onToggleMock}
+        />,
+      );
+
+      // Assert
+      const toggleButton = screen.getByTestId("toggle-button");
+      expect(toggleButton).toHaveTextContent("test_function");
+    });
+
+    it("should display title from V1 format root level", () => {
+      // Arrange
+      const v1Tool = {
+        title: "V1 Tool Title",
+        description: "V1 description",
+        parameters: { type: "object" },
+      };
+
+      // Act
+      renderWithProviders(
+        <ToolItem
+          tool={v1Tool}
+          index={0}
+          isExpanded={false}
+          onToggle={onToggleMock}
+        />,
+      );
+
+      // Assert
+      const toggleButton = screen.getByTestId("toggle-button");
+      expect(toggleButton).toHaveTextContent("V1 Tool Title");
+    });
+
+    it("should prioritize root title over annotations.title in V1 format", () => {
+      // Arrange
+      const v1Tool = {
+        title: "Root Title",
+        annotations: {
+          title: "Annotations Title",
+        },
+        description: "Description",
+      };
+
+      // Act
+      renderWithProviders(
+        <ToolItem
+          tool={v1Tool}
+          index={0}
+          isExpanded={false}
+          onToggle={onToggleMock}
+        />,
+      );
+
+      // Assert
+      const toggleButton = screen.getByTestId("toggle-button");
+      expect(toggleButton).toHaveTextContent("Root Title");
+    });
+
+    it("should fallback to annotations.title when root title is missing", () => {
+      // Arrange
+      const v1Tool = {
+        annotations: {
+          title: "Annotations Title",
+        },
+        description: "Description",
+      };
+
+      // Act
+      renderWithProviders(
+        <ToolItem
+          tool={v1Tool}
+          index={0}
+          isExpanded={false}
+          onToggle={onToggleMock}
+        />,
+      );
+
+      // Assert
+      const toggleButton = screen.getByTestId("toggle-button");
+      expect(toggleButton).toHaveTextContent("Annotations Title");
+    });
+
+    it("should display empty string when no name or title is available", () => {
+      // Arrange
+      const toolWithoutName = {
+        description: "Description only",
+      };
+
+      // Act
+      renderWithProviders(
+        <ToolItem
+          tool={toolWithoutName}
+          index={0}
+          isExpanded={false}
+          onToggle={onToggleMock}
+        />,
+      );
+
+      // Assert
+      const toggleButton = screen.getByTestId("toggle-button");
+      expect(toggleButton).toHaveTextContent("");
+    });
+  });
+
+  describe("Description Extraction", () => {
+    it("should display description from V0 format function.description when expanded", () => {
+      // Arrange
+      const v0Tool: ChatCompletionToolParam = {
+        type: "function",
+        function: {
+          name: "test_function",
+          description: "V0 function description",
+          parameters: {},
+        },
+      };
+
+      // Act
+      renderWithProviders(
+        <ToolItem
+          tool={v0Tool}
+          index={0}
+          isExpanded={true}
+          onToggle={onToggleMock}
+        />,
+      );
+
+      // Assert
+      const markdownRenderer = screen.getByTestId("markdown-renderer");
+      expect(markdownRenderer).toHaveTextContent("V0 function description");
+    });
+
+    it("should display description from V1 format root level when expanded", () => {
+      // Arrange
+      const v1Tool = {
+        title: "V1 Tool",
+        description: "V1 root description",
+        parameters: {},
+      };
+
+      // Act
+      renderWithProviders(
+        <ToolItem
+          tool={v1Tool}
+          index={0}
+          isExpanded={true}
+          onToggle={onToggleMock}
+        />,
+      );
+
+      // Assert
+      const markdownRenderer = screen.getByTestId("markdown-renderer");
+      expect(markdownRenderer).toHaveTextContent("V1 root description");
+    });
+
+    it("should prioritize root description over function.description in V1 format", () => {
+      // Arrange
+      const v1Tool = {
+        title: "V1 Tool",
+        description: "Root description",
+        function: {
+          description: "Function description",
+        },
+      };
+
+      // Act
+      renderWithProviders(
+        <ToolItem
+          tool={v1Tool}
+          index={0}
+          isExpanded={true}
+          onToggle={onToggleMock}
+        />,
+      );
+
+      // Assert
+      const markdownRenderer = screen.getByTestId("markdown-renderer");
+      expect(markdownRenderer).toHaveTextContent("Root description");
+    });
+
+    it("should display empty string when no description is available", () => {
+      // Arrange
+      const toolWithoutDescription = {
+        title: "Tool Name",
+      };
+
+      // Act
+      renderWithProviders(
+        <ToolItem
+          tool={toolWithoutDescription}
+          index={0}
+          isExpanded={true}
+          onToggle={onToggleMock}
+        />,
+      );
+
+      // Assert
+      const markdownRenderer = screen.getByTestId("markdown-renderer");
+      expect(markdownRenderer).toHaveTextContent("");
+    });
+
+    it("should not display description when collapsed", () => {
+      // Arrange
+      const v0Tool: ChatCompletionToolParam = {
+        type: "function",
+        function: {
+          name: "test_function",
+          description: "Should not be visible",
+          parameters: {},
+        },
+      };
+
+      // Act
+      renderWithProviders(
+        <ToolItem
+          tool={v0Tool}
+          index={0}
+          isExpanded={false}
+          onToggle={onToggleMock}
+        />,
+      );
+
+      // Assert
+      expect(screen.queryByTestId("markdown-renderer")).not.toBeInTheDocument();
+    });
+  });
+
+  describe("Parameters Extraction", () => {
+    it("should display parameters from V0 format function.parameters when expanded", () => {
+      // Arrange
+      const v0Tool: ChatCompletionToolParam = {
+        type: "function",
+        function: {
+          name: "test_function",
+          description: "Description",
+          parameters: {
+            type: "object",
+            properties: {
+              param1: { type: "string" },
+            },
+          },
+        },
+      };
+
+      // Act
+      renderWithProviders(
+        <ToolItem
+          tool={v0Tool}
+          index={0}
+          isExpanded={true}
+          onToggle={onToggleMock}
+        />,
+      );
+
+      // Assert
+      const toolParameters = screen.getByTestId("tool-parameters");
+      expect(toolParameters).toBeInTheDocument();
+      // Verify that the parameters are rendered (ReactJsonView will render the JSON)
+      expect(toolParameters).toHaveTextContent("param1");
+    });
+
+    it("should display parameters from V1 format root level when expanded", () => {
+      // Arrange
+      const v1Tool = {
+        title: "V1 Tool",
+        description: "Description",
+        parameters: {
+          type: "object",
+          properties: {
+            param2: { type: "number" },
+          },
+        },
+      };
+
+      // Act
+      renderWithProviders(
+        <ToolItem
+          tool={v1Tool}
+          index={0}
+          isExpanded={true}
+          onToggle={onToggleMock}
+        />,
+      );
+
+      // Assert
+      const toolParameters = screen.getByTestId("tool-parameters");
+      expect(toolParameters).toBeInTheDocument();
+      // Verify that the parameters are rendered (ReactJsonView will render the JSON)
+      expect(toolParameters).toHaveTextContent("param2");
+    });
+
+    it("should prioritize function.parameters over root parameters in V0 format", () => {
+      // Arrange
+      const v0Tool = {
+        type: "function",
+        function: {
+          name: "test_function",
+          description: "Description",
+          parameters: {
+            type: "object",
+            source: "function",
+          },
+        },
+        parameters: {
+          type: "object",
+          source: "root",
+        },
+      };
+
+      // Act
+      renderWithProviders(
+        <ToolItem
+          tool={v0Tool}
+          index={0}
+          isExpanded={true}
+          onToggle={onToggleMock}
+        />,
+      );
+
+      // Assert
+      const toolParameters = screen.getByTestId("tool-parameters");
+      expect(toolParameters).toBeInTheDocument();
+      // Verify that function parameters are used (not root parameters)
+      expect(toolParameters).toHaveTextContent("function");
+      expect(toolParameters).not.toHaveTextContent("root");
+    });
+
+    it("should not display parameters when they are null", () => {
+      // Arrange
+      const toolWithoutParameters = {
+        title: "Tool Name",
+        description: "Description",
+      };
+
+      // Act
+      renderWithProviders(
+        <ToolItem
+          tool={toolWithoutParameters}
+          index={0}
+          isExpanded={true}
+          onToggle={onToggleMock}
+        />,
+      );
+
+      // Assert
+      expect(screen.queryByTestId("tool-parameters")).not.toBeInTheDocument();
+    });
+
+    it("should not display parameters when collapsed", () => {
+      // Arrange
+      const v0Tool: ChatCompletionToolParam = {
+        type: "function",
+        function: {
+          name: "test_function",
+          description: "Description",
+          parameters: {
+            type: "object",
+          },
+        },
+      };
+
+      // Act
+      renderWithProviders(
+        <ToolItem
+          tool={v0Tool}
+          index={0}
+          isExpanded={false}
+          onToggle={onToggleMock}
+        />,
+      );
+
+      // Assert
+      expect(screen.queryByTestId("tool-parameters")).not.toBeInTheDocument();
+    });
+  });
+
+  describe("Toggle Functionality", () => {
+    it("should call onToggle with correct index when toggle button is clicked", async () => {
+      // Arrange
+      const v0Tool: ChatCompletionToolParam = {
+        type: "function",
+        function: {
+          name: "test_function",
+          description: "Description",
+          parameters: {},
+        },
+      };
+
+      // Act
+      renderWithProviders(
+        <ToolItem
+          tool={v0Tool}
+          index={2}
+          isExpanded={false}
+          onToggle={onToggleMock}
+        />,
+      );
+
+      const toggleButton = screen.getByTestId("toggle-button");
+      await user.click(toggleButton);
+
+      // Assert
+      expect(onToggleMock).toHaveBeenCalledOnce();
+      expect(onToggleMock).toHaveBeenCalledWith(2);
+    });
+
+    it("should show expanded content when isExpanded is true", () => {
+      // Arrange
+      const v0Tool: ChatCompletionToolParam = {
+        type: "function",
+        function: {
+          name: "test_function",
+          description: "Test description",
+          parameters: { type: "object" },
+        },
+      };
+
+      // Act
+      renderWithProviders(
+        <ToolItem
+          tool={v0Tool}
+          index={0}
+          isExpanded={true}
+          onToggle={onToggleMock}
+        />,
+      );
+
+      // Assert
+      expect(screen.getByTestId("markdown-renderer")).toBeInTheDocument();
+      expect(screen.getByTestId("tool-parameters")).toBeInTheDocument();
+    });
+
+    it("should hide expanded content when isExpanded is false", () => {
+      // Arrange
+      const v0Tool: ChatCompletionToolParam = {
+        type: "function",
+        function: {
+          name: "test_function",
+          description: "Test description",
+          parameters: { type: "object" },
+        },
+      };
+
+      // Act
+      renderWithProviders(
+        <ToolItem
+          tool={v0Tool}
+          index={0}
+          isExpanded={false}
+          onToggle={onToggleMock}
+        />,
+      );
+
+      // Assert
+      expect(screen.queryByTestId("markdown-renderer")).not.toBeInTheDocument();
+      expect(screen.queryByTestId("tool-parameters")).not.toBeInTheDocument();
+    });
+  });
+
+  describe("Complex Scenarios", () => {
+    it("should handle V0 format with type field correctly", () => {
+      // Arrange
+      const v0Tool = {
+        type: "function",
+        function: {
+          name: "typed_function",
+          description: "Typed description",
+          parameters: { type: "object" },
+        },
+      };
+
+      // Act
+      renderWithProviders(
+        <ToolItem
+          tool={v0Tool}
+          index={0}
+          isExpanded={true}
+          onToggle={onToggleMock}
+        />,
+      );
+
+      // Assert
+      expect(screen.getByTestId("toggle-button")).toHaveTextContent(
+        "typed_function",
+      );
+      expect(screen.getByTestId("markdown-renderer")).toHaveTextContent(
+        "Typed description",
+      );
+      expect(screen.getByTestId("tool-parameters")).toBeInTheDocument();
+    });
+
+    it("should handle tool data where function is at root level (fallback behavior)", () => {
+      // Arrange
+      const toolWithFunctionAtRoot = {
+        name: "root_function",
+        description: "Root function description",
+        parameters: { type: "object" },
+      };
+
+      // Act
+      renderWithProviders(
+        <ToolItem
+          tool={toolWithFunctionAtRoot}
+          index={0}
+          isExpanded={true}
+          onToggle={onToggleMock}
+        />,
+      );
+
+      // Assert
+      expect(screen.getByTestId("toggle-button")).toHaveTextContent(
+        "root_function",
+      );
+      expect(screen.getByTestId("markdown-renderer")).toHaveTextContent(
+        "Root function description",
+      );
+      expect(screen.getByTestId("tool-parameters")).toBeInTheDocument();
+    });
+  });
+});
diff --git a/frontend/src/components/features/conversation-panel/system-message-modal/system-message-header.tsx b/frontend/src/components/features/conversation-panel/system-message-modal/system-message-header.tsx
index e1ed8fb401..f974f9c055 100644
--- a/frontend/src/components/features/conversation-panel/system-message-modal/system-message-header.tsx
+++ b/frontend/src/components/features/conversation-panel/system-message-modal/system-message-header.tsx
@@ -1,6 +1,7 @@
 import { useTranslation } from "react-i18next";
 import { BaseModalTitle } from "#/components/shared/modals/confirmation-modals/base-modal";
 import { Typography } from "#/ui/typography";
+import { cn } from "#/utils/utils";
 
 interface SystemMessageHeaderProps {
   agentClass: string | null;
@@ -14,7 +15,12 @@ export function SystemMessageHeader({
   const { t } = useTranslation();
 
   return (
-    <div className="flex flex-col gap-6 w-full">
+    <div
+      className={cn(
+        "flex flex-col gap-6 w-full",
+        !!agentClass && !!openhandsVersion ? "gap-6" : "gap-0",
+      )}
+    >
       <BaseModalTitle title={t("SYSTEM_MESSAGE_MODAL$TITLE")} />
       <div className="flex flex-col gap-2">
         {agentClass && (
diff --git a/frontend/src/components/features/conversation-panel/system-message-modal/toggle-button.tsx b/frontend/src/components/features/conversation-panel/system-message-modal/toggle-button.tsx
index cd2d1d972b..eff4ed4a4f 100644
--- a/frontend/src/components/features/conversation-panel/system-message-modal/toggle-button.tsx
+++ b/frontend/src/components/features/conversation-panel/system-message-modal/toggle-button.tsx
@@ -17,6 +17,7 @@ export function ToggleButton({
   return (
     <button
       type="button"
+      data-testid="toggle-button"
       onClick={onClick}
       className={`w-full py-3 px-2 text-left flex items-center justify-between hover:bg-gray-700 transition-colors ${className || ""}`}
     >
diff --git a/frontend/src/components/features/conversation-panel/system-message-modal/tool-item.tsx b/frontend/src/components/features/conversation-panel/system-message-modal/tool-item.tsx
index 5b146d28e9..61cfc7332a 100644
--- a/frontend/src/components/features/conversation-panel/system-message-modal/tool-item.tsx
+++ b/frontend/src/components/features/conversation-panel/system-message-modal/tool-item.tsx
@@ -1,7 +1,7 @@
-import { Typography } from "#/ui/typography";
 import { ToolParameters } from "./tool-parameters";
 import { ToggleButton } from "./toggle-button";
 import { ChatCompletionToolParam } from "#/types/v1/core";
+import { MarkdownRenderer } from "../../markdown/markdown-renderer";
 
 interface FunctionData {
   name?: string;
@@ -10,11 +10,18 @@ interface FunctionData {
 }
 
 interface ToolData {
+  // V0/OpenAI format
   type?: string;
   function?: FunctionData;
   name?: string;
   description?: string;
   parameters?: Record<string, unknown>;
+  // V1 format
+  title?: string;
+  kind?: string;
+  annotations?: {
+    title?: string;
+  };
 }
 
 interface ToolItemProps {
@@ -28,17 +35,33 @@ export function ToolItem({ tool, index, isExpanded, onToggle }: ToolItemProps) {
   // Extract function data from the nested structure
   const toolData = tool as ToolData;
   const functionData = toolData.function || toolData;
+
+  // Extract tool name/title - support both V0 and V1 formats
   const name =
+    // V1 format: check for title field (root level or in annotations)
+    toolData.title ||
+    toolData.annotations?.title ||
+    // V0 format: check for function.name or name
     functionData.name ||
     (toolData.type === "function" && toolData.function?.name) ||
     "";
+
+  // Extract description - support both V0 and V1 formats
   const description =
+    // V1 format: description at root level
+    toolData.description ||
+    // V0 format: description in function object
     functionData.description ||
     (toolData.type === "function" && toolData.function?.description) ||
     "";
+
+  // Extract parameters - support both V0 and V1 formats
   const parameters =
+    // V0 format: parameters in function object
     functionData.parameters ||
     (toolData.type === "function" && toolData.function?.parameters) ||
+    // V1 format: parameters at root level (if present)
+    toolData.parameters ||
     null;
 
   return (
@@ -51,10 +74,8 @@ export function ToolItem({ tool, index, isExpanded, onToggle }: ToolItemProps) {
 
       {isExpanded && (
         <div className="px-2 pb-3 pt-1">
-          <div className="mt-2 mb-3">
-            <Typography.Text className="text-sm whitespace-pre-wrap text-gray-300 leading-relaxed">
-              {String(description)}
-            </Typography.Text>
+          <div className="mt-2 mb-3 text-sm text-gray-300 leading-relaxed">
+            <MarkdownRenderer>{String(description)}</MarkdownRenderer>
           </div>
 
           {/* Parameters section */}
diff --git a/frontend/src/components/features/conversation-panel/system-message-modal/tool-parameters.tsx b/frontend/src/components/features/conversation-panel/system-message-modal/tool-parameters.tsx
index a37db0ddca..a0e0f54bbb 100644
--- a/frontend/src/components/features/conversation-panel/system-message-modal/tool-parameters.tsx
+++ b/frontend/src/components/features/conversation-panel/system-message-modal/tool-parameters.tsx
@@ -11,7 +11,7 @@ export function ToolParameters({ parameters }: ToolParametersProps) {
   const { t } = useTranslation();
 
   return (
-    <div className="mt-2">
+    <div className="mt-2" data-testid="tool-parameters">
       <Typography.Text className="text-sm font-semibold text-gray-300">
         {t("SYSTEM_MESSAGE_MODAL$PARAMETERS")}
       </Typography.Text>
diff --git a/frontend/src/components/features/markdown/markdown-renderer.tsx b/frontend/src/components/features/markdown/markdown-renderer.tsx
index 0cb55498d6..15a6db26ca 100644
--- a/frontend/src/components/features/markdown/markdown-renderer.tsx
+++ b/frontend/src/components/features/markdown/markdown-renderer.tsx
@@ -73,8 +73,13 @@ export function MarkdownRenderer({
   const markdownContent = content ?? children ?? "";
 
   return (
-    <Markdown components={components} remarkPlugins={[remarkGfm, remarkBreaks]}>
-      {markdownContent}
-    </Markdown>
+    <div data-testid="markdown-renderer">
+      <Markdown
+        components={components}
+        remarkPlugins={[remarkGfm, remarkBreaks]}
+      >
+        {markdownContent}
+      </Markdown>
+    </div>
   );
 }