In what could be a nasty spat Microsoft is set to take on Apple in a battle aimed at knocking a dent in iPod sales and iTunes.

Microsoft is preparing to wage a high-stakes battle against Apple and its iPod digital music player, a move that could bring to mind the battle between the tech giant’s Xbox video game console and Sony’s PlayStation.

Microsoft is quietly laying the groundwork to launch its own digital music player and music service that would rival the iPod and the popular iTunes music service, according to multiple sources close to the major record labels.

According to these sources, Microsoft has quietly restarted licensing talks as a precursor to launching its own digital music store.

Last year, Microsoft ended such talks with the record labels and temporarily shelved plans to launch its own music store. More recently, Microsoft partnered with MTV to launch Urge, a subscription music service.

 At the same time, Microsoft executives have begun making the rounds of the music companies to demonstrate its own digital music player – the existence of which Microsoft executives have never publicly acknowledged.

Sources say the device plays both video and MP3s, and some who have seen it say the quality of the video surpasses that of the video iPod.

“It seems like an exact head-to-head competition with Apple,” said one source. “It’s really like an Apple approach, to control the device and the whole stack of technology. This is like Xbox versus PlayStation.”

Sources describe Microsoft’s latest strategy for digital music as a reversal of its previous plans, which called for partnering with technology companies and opening up any digital music service to a variety of devices.

While previous talk centered on Microsoft offering a subscription music service, the company is now focused more on offering a music service that replicates the iTunes model of selling individual songs for download, according to a source.

“But there may be a subscription component,” said this person.

In recent weeks, Microsoft shot down rumors that it had partnered with several consumer electronics companies in Japan to launch an iPod rival.

In public settings, Microsoft execs have been coy about rumored plans to take on the iPod.

At a recent conference hosted by The Wall Street Journal, Microsoft Chairman Bill Gates reportedly said, “There is such a rumor,” when asked whether the company plans to roll out a digital music player.

Apple, meanwhile, is fresh from its victory over the music labels in its recent round of licensing talks. Apple succeeded in denying the labels’ wish for variable pricing, and the current standard of 99 cents per track remains in place.

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