The TOS that the Microsoft YouTube app violates has to do with it blocking ads and allowing downloads of videos from Google's YouTube site.
From the letter:
"YouTube’s agreements with creators give them choices inhow their content is presented and distributed, and your application takes away that control.The YouTube Terms of Service and API Terms of Service, posted at https://www.youtube.com/t/terms and https://developers.google.com/youtube/terms, were written to protect content creators from this type of abuse. They clearly prohibit downloads of videos from the site and prohibit accessing any portion of YouTube videos by any means other than through the use of an authorized YouTube player. They also bar applications that modify, replace, interfere with or block advertisements placed by YouTube in videos."
Google is requesting that Microsoft immediately withdraw the app from the Windows Phone Store and disable existing downloads of it by May 22.
I reached out to both Microsoft and Google for comment on the letter. A Google spokesperson said the company was not offering any comment. No word from Microsoft so far.
Update: Microsoft's official statement via a spokesperson:
"YouTube is consistently one of the top apps downloaded by smartphone users on all platforms, but Google has refused to work with us to develop an app on par with other platforms. Since we updated the YouTube app to ensure our mutual customers a similar YouTube experience, ratings and feedback have been overwhelmingly positive. We’d be more than happy to include advertising but need Google to provide us access to the necessary APIs. In light of Larry Page’s comments today calling for more interoperability and less negativity, we look forward to solving this matter together for our mutual customers."
Also the timing of The Verge's report is interesting. Just minutes before it went live, Google's CEO Larry Page, during a Q&A session at the company's annual Google I/O developer conference, criticized Microsoft for taking advantage of Google by interoperating with its Google Talk messaging service and not reciprocating by providing free access to APIs for its own messaging service (presumably Skype).