The new subsidiary, currently just referred to as Newco, will bring together the expertise of both companies to "accelerate the transition" from physical books to e-reading.
In a joint press statement, Microsoft and Barnes & Noble said that e-reading is "revolutionising the way people consume, create, share and enjoy digital content".
Formed in January, Newco brings together the digital and education businesses of Barnes & Noble, including the Nook eReader that competes with Amazon's market leading Kindle in the US.
Microsoft will make a $300 million investment in Newco in exchange for an approximately 17.6% equity stake. Barnes & Noble will own approximately 82.4% of the new subsidiary, which will have an ongoing relationship with the company's retail stores. Barnes & Noble said that it has not yet decided on the final name for Newco.
Microsoft has made the investment so that eBooks form a big part of Windows 8, particularly so that tablets running the new operating system can compete with Apple's iPad and Amazon's popular Kindle Fire.
Barnes & Noble chief executive William Lynch said: "The formation of Newco and our relationship with Microsoft are important parts of our strategy to capitalise on the rapid growth of the Nook business, and to solidify our position as a leader in the exploding market for digital content in the consumer and education segments.
"Microsoft's investment in Newco, and our exciting collaboration to bring world-class digital reading technologies and content to the Windows platform and its hundreds of millions of users, will allow us to significantly expand the business."
Microsoft president Andy Lees added: "The shift to digital is putting the world's libraries and newsstands in the palm of every person's hand, and is the beginning of a journey that will impact how people read, interact with, and enjoy new forms of content.
"Our complementary assets will accelerate e-reading innovation across a broad range of Windows devices, enabling people to not just read stories, but to be part of them. We're at the cusp of a revolution in reading."
Barnes & Noble and Microsoft have also settled their patent litigation, meaning Newco will have a royalty-bearing license under Microsoft's patents for the Nook eReader and tablet products.
The companies said that this "paves the way for both companies to collaborate and reach a broader set of customers".
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