Microsoft will be forced to hand customer data including bank details and emails to the US government after a search warrant was upheld on Friday, even though the information is stored on a server in Dublin.
The company had challenged the warrant on the basis that the US government should not be able to search information stored entirely on overseas servers.
But a New York Magistrate, Judge James Francis, ruled that Microsoft and other ISPs including Google could not refuse to hand over customer data even if the information was held on foreign soil.
In a blog post following the ruling, Microsoft's deputy general counsel David Howard said: "A US prosecutor cannot obtain a US warrant to search someone's home located in another country, just as another country's prosecutor cannot obtain a court order in her home country to conduct a search in the United States.
"We think the same rules should apply in the online world, but the government disagrees."
Judge Francis ruled that this was true of "traditional" search warrants but not warrants seeking digital content, which are governed by a federal law called the Stored Communications Act.
This comes at a time when trust in information security and data confidentiality is at the forefront of the ICT world following the widely reported Edward Snowden leaks.
Microsoft has been publicly anti "government snooping" and has previously promised to alert customers if they had received requests from third parties to view their data.
Last year, Brad Smith, General Counsel & Executive Vice President, Legal & Corporate Affairs, Microsoft said: "We also will take new steps to reinforce legal protections for our customers' data. For example, we are committed to notifying business and government customers if we receive legal orders related to their data.
"Where a gag order attempts to prohibit us from doing this, we will challenge it in court. We've done this successfully in the past, and we will continue to do so in the future to preserve our ability to alert customers when governments seek to obtain their data. And we'll assert available jurisdictional objections to legal demands when governments seek this type of customer content that is stored in another country."
The name of the agency who originally issued the search warrant has not been disclosed.