Both DOS and Atari used FAT format. The capacity was identical, but MS-DOS would have trouble reading Atari ST floppies because Atari had followed the published standard and wrote two copies of the allocation table to the disk, and MS-DOS would only write one and overwrite the second one with data and corrupt the disk. The 'extra space' was the space that was supposed to be taken by the redundant file allocation table.
The rule was if you wanted to move files between systems, you had to format the floppy on MS-DOS, then you can use it everywhere. If you formatted on the Atari and used it on MS-DOS, you would end up using it nowhere.
I didn’t grow up with floppies, so pardon my ignorance, but two questions: (1) which FAT? I figure it can’t be FAT32, but that still leaves FAT12 and FAT16, both of which Microsoft helped develop. And (2) since Microsoft helped develop it, were they just not following their own spec? Because that doesn’t make sense (not that you’re wrong).
MS-DOS was also not the only DOS on the market. DR-DOS was very popular at the time of the Atari ST. As far as I know DR-DOS also followed the published specification and Digital Research (DR) was Microsoft's biggest competition. Atari also used Digital Reasearch's GEM as their "desktop" GUI. GEM was a direct competitor to Microsoft's new Macintosh-killer product called "Windows". CorelDraw and WordPerfect used GEM, MS Word and MS Excel used Windows.
The rule was if you wanted to move files between systems, you had to format the floppy on MS-DOS, then you can use it everywhere. If you formatted on the Atari and used it on MS-DOS, you would end up using it nowhere.