Earlier this month, Microsoft published an updated YouTube app for Windows Phone that significantly enhanced its functionality, although as the app didn't comply with a number of Google's guidelines, Microsoft was handed a cease and desist letter to remove the app from the Windows Phone Store. Google specifically complained that the app doesn't show ads to users, which is (of course) YouTube's main revenue stream.
Microsoft said that they would be happy to comply with Google's guidelines and update the app to include ads if given access to their API, and rather than removing the app, today Microsoft has decided to update it to bring it inline with the guidelines. However, the main concern raised by Google over the lack of ads hasn't been addressed in this update; the Windows Phone app is still ad free while watching videos.
What has been addressed is the offline video downloader - a feature that doesn't comply with the guidelines - with the functionality being completely removed from the app. Also, Microsoft has addressed issues surrounding restricted videos, as mentioned in their statement to news outlets:
Microsoft updated the Windows Phone YouTube app to address the restricted video and offline video access concerns voiced by Google last week. We have been in contact with Google and continue to believe that our two companies can work together to hone an app that benefits our mutual customers, partners and content providers. We're earning new customers every day, with IDC reporting recently that Windows Phone posted the largest year-over-year gain among leading operating systems. We look forward to working with Google to maintain a great YouTube experience for the growing number of people who rely on both of our respective products.
As the original batch of issues haven't been fully resolved with this update, it wouldn't surprise us if Google still demands that Microsoft remove the app from the Store. While the two companies battle it out over YouTube on Windows Phone, users can grab the updated YouTube app from the Windows Phone Store right now.