The service, which is expected to be made available in the UK by the end of July, will offer web users the ability to stream tracks for free as well as the option to download them for a charge.
Peter Bale, executive producer of MSN, Microsoft's news and entertainment portal, told The Telegraph: "Music is an important area for Microsoft. We are looking at launching a music streaming service imminently."
"It will be a similar principle to Spotify but we are still examining how the business model will work, and trying to figure out what will work best for both consumer and Microsoft."
It is hoped the service will improve the appeal of Microsoft's Zune digital audio player. Microsoft also suggested the service would be linked to its Xbox console. Details of how this will work have not been released yet.
Microsoft said it had not identified a download partner but said it is in discussions with a number of companies.
Spotify is a free-to-use service that plays tracks peppered with adverts just like commercial radio. However, for a £9.99 monthly subscription, users can enjoy ad-free listening. It also allows users to create 'collaborative' playlists, which are assigned their own web addresses, and can then be added to by other Spotify listeners.
A partnership with 7Digital means users can click the 'Buy From 7digital.com' link while streaming tracks on the service and navigate to 7Digital's site where users can purchase 320kbps MP3 files from a catalogue of six million tracks.
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See also: Spotify offers first audiobook