diff --git a/src/server/project.ts b/src/server/project.ts
index b0d2c427aa7d9..1a114a2d16b39 100644
--- a/src/server/project.ts
+++ b/src/server/project.ts
@@ -1762,7 +1762,11 @@ namespace ts.server {
             const dirPathWithTrailingDirectorySeparator = `${dirPath}${directorySeparator}`;
             return forEachKey(
                 this.mapOfDeclarationDirectories!,
-                declDirPath => dirPath === declDirPath || startsWith(declDirPath, dirPathWithTrailingDirectorySeparator)
+                declDirPath => dirPath === declDirPath ||
+                    // Any parent directory of declaration dir
+                    startsWith(declDirPath, dirPathWithTrailingDirectorySeparator) ||
+                    // Any directory inside declaration dir
+                    startsWith(dirPath, `${declDirPath}/`)
             );
         }
 
@@ -1799,6 +1803,16 @@ namespace ts.server {
             return this.fileOrDirectoryExistsUsingSource(path, /*isFile*/ false);
         }
 
+        /**
+         * Call super.getDirectories only if directory actually present on the host
+         * This is needed to ensure that we arent getting directories that we fake about presence for
+         */
+        getDirectories(path: string): string[] {
+            return !this.useSourceOfProjectReferenceRedirect() || !this.projectReferenceCallbacks || super.directoryExists(path) ?
+                super.getDirectories(path) :
+                [];
+        }
+
         private realpathIfSymlinkedProjectReferenceDts(s: string): string | undefined {
             return this.symlinkedFiles && this.symlinkedFiles.get(this.toPath(s));
         }
@@ -1817,7 +1831,7 @@ namespace ts.server {
             const directoryPath = ensureTrailingDirectorySeparator(this.toPath(directory));
             if (this.symlinkedDirectories.has(directoryPath)) return;
 
-            const real = this.projectService.host.realpath!(directory);
+            const real = normalizePath(this.projectService.host.realpath!(directory));
             let realPath: Path;
             if (real === directory ||
                 (realPath = ensureTrailingDirectorySeparator(this.toPath(real))) === directoryPath) {
diff --git a/src/testRunner/unittests/tsserver/projectReferences.ts b/src/testRunner/unittests/tsserver/projectReferences.ts
index 0966ad911e356..cde95f6dd52fe 100644
--- a/src/testRunner/unittests/tsserver/projectReferences.ts
+++ b/src/testRunner/unittests/tsserver/projectReferences.ts
@@ -1375,78 +1375,70 @@ function foo() {
         });
 
         describe("when references are monorepo like with symlinks", () => {
-            function verifySession(alreadyBuilt: boolean, extraOptions: CompilerOptions) {
-                const bPackageJson: File = {
-                    path: `${projectRoot}/packages/B/package.json`,
-                    content: JSON.stringify({
-                        main: "lib/index.js",
-                        types: "lib/index.d.ts"
-                    })
-                };
+            interface Packages {
+                bPackageJson: File;
+                aTest: File;
+                bFoo: File;
+                bBar: File;
+            }
+            function verifySymlinkScenario(packages: () => Packages) {
+                describe("when solution is not built", () => {
+                    it("with preserveSymlinks turned off", () => {
+                        verifySession(packages(), /*alreadyBuilt*/ false, {});
+                    });
+
+                    it("with preserveSymlinks turned on", () => {
+                        verifySession(packages(), /*alreadyBuilt*/ false, { preserveSymlinks: true });
+                    });
+                });
+
+                describe("when solution is already built", () => {
+                    it("with preserveSymlinks turned off", () => {
+                        verifySession(packages(), /*alreadyBuilt*/ true, {});
+                    });
+
+                    it("with preserveSymlinks turned on", () => {
+                        verifySession(packages(), /*alreadyBuilt*/ true, { preserveSymlinks: true });
+                    });
+                });
+            }
+
+            function verifySession({ bPackageJson, aTest, bFoo, bBar }: Packages, alreadyBuilt: boolean, extraOptions: CompilerOptions) {
                 const aConfig = config("A", extraOptions, ["../B"]);
                 const bConfig = config("B", extraOptions);
-                const aIndex = index("A", `import { foo } from 'b';
-import { bar } from 'b/lib/bar';
-foo();
-bar();`);
-                const bIndex = index("B", `export function foo() { }`);
-                const bBar: File = {
-                    path: `${projectRoot}/packages/B/src/bar.ts`,
-                    content: `export function bar() { }`
-                };
                 const bSymlink: SymLink = {
                     path: `${projectRoot}/node_modules/b`,
                     symLink: `${projectRoot}/packages/B`
                 };
-
-                const files = [libFile, bPackageJson, aConfig, bConfig, aIndex, bIndex, bBar, bSymlink];
+                const files = [libFile, bPackageJson, aConfig, bConfig, aTest, bFoo, bBar, bSymlink];
                 const host = alreadyBuilt ?
                     createHost(files, [aConfig.path]) :
                     createServerHost(files);
 
                 // Create symlink in node module
                 const session = createSession(host, { canUseEvents: true });
-                openFilesForSession([aIndex], session);
+                openFilesForSession([aTest], session);
                 const service = session.getProjectService();
                 const project = service.configuredProjects.get(aConfig.path.toLowerCase())!;
                 assert.deepEqual(project.getAllProjectErrors(), []);
                 checkProjectActualFiles(
                     project,
-                    [aConfig.path, aIndex.path, bIndex.path, bBar.path, libFile.path]
+                    [aConfig.path, aTest.path, bFoo.path, bBar.path, libFile.path]
                 );
                 verifyGetErrRequest({
                     host,
                     session,
                     expected: [
-                        { file: aIndex, syntax: [], semantic: [], suggestion: [] }
+                        { file: aTest, syntax: [], semantic: [], suggestion: [] }
                     ]
                 });
             }
 
-            function verifySymlinkScenario(alreadyBuilt: boolean) {
-                it("with preserveSymlinks turned off", () => {
-                    verifySession(alreadyBuilt, {});
-                });
-
-                it("with preserveSymlinks turned on", () => {
-                    verifySession(alreadyBuilt, { preserveSymlinks: true });
-                });
-            }
-
-            describe("when solution is not built", () => {
-                verifySymlinkScenario(/*alreadyBuilt*/ false);
-            });
-
-            describe("when solution is already built", () => {
-                verifySymlinkScenario(/*alreadyBuilt*/ true);
-            });
-
             function config(packageName: string, extraOptions: CompilerOptions, references?: string[]): File {
                 return {
                     path: `${projectRoot}/packages/${packageName}/tsconfig.json`,
                     content: JSON.stringify({
                         compilerOptions: {
-                            baseUrl: ".",
                             outDir: "lib",
                             rootDir: "src",
                             composite: true,
@@ -1458,12 +1450,45 @@ bar();`);
                 };
             }
 
-            function index(packageName: string, content: string): File {
+            function file(packageName: string, fileName: string, content: string): File {
                 return {
-                    path: `${projectRoot}/packages/${packageName}/src/index.ts`,
+                    path: `${projectRoot}/packages/${packageName}/src/${fileName}`,
                     content
                 };
             }
+
+            describe("when packageJson has types field and has index.ts", () => {
+                verifySymlinkScenario(() => ({
+                    bPackageJson: {
+                        path: `${projectRoot}/packages/B/package.json`,
+                        content: JSON.stringify({
+                            main: "lib/index.js",
+                            types: "lib/index.d.ts"
+                        })
+                    },
+                    aTest: file("A", "index.ts", `import { foo } from 'b';
+import { bar } from 'b/lib/bar';
+foo();
+bar();`),
+                    bFoo: file("B", "index.ts", `export function foo() { }`),
+                    bBar: file("B", "bar.ts", `export function bar() { }`)
+                }));
+            });
+
+            describe("when referencing file from subFolder", () => {
+                verifySymlinkScenario(() => ({
+                    bPackageJson: {
+                        path: `${projectRoot}/packages/B/package.json`,
+                        content: "{}"
+                    },
+                    aTest: file("A", "test.ts", `import { foo } from 'b/lib/foo';
+import { bar } from 'b/lib/bar/foo';
+foo();
+bar();`),
+                    bFoo: file("B", "foo.ts", `export function foo() { }`),
+                    bBar: file("B", "bar/foo.ts", `export function bar() { }`)
+                }));
+            });
         });
     });
 }
diff --git a/tests/baselines/reference/api/tsserverlibrary.d.ts b/tests/baselines/reference/api/tsserverlibrary.d.ts
index 6fbc32952f844..c6a532b6d7ad3 100644
--- a/tests/baselines/reference/api/tsserverlibrary.d.ts
+++ b/tests/baselines/reference/api/tsserverlibrary.d.ts
@@ -8705,6 +8705,11 @@ declare namespace ts.server {
          * If it is it returns true irrespective of whether that directory exists on host
          */
         directoryExists(path: string): boolean;
+        /**
+         * Call super.getDirectories only if directory actually present on the host
+         * This is needed to ensure that we arent getting directories that we fake about presence for
+         */
+        getDirectories(path: string): string[];
         private realpathIfSymlinkedProjectReferenceDts;
         private getRealpath;
         private handleDirectoryCouldBeSymlink;