Can you confirm if downgrade rights apply to virtual instances of the server OS that was originally licensed?
In this case below the customer is licensed for Windows Server Datacenter Edition. If they have multiple VMs of this installed, can these VMs be downgraded to the 2003 edition?
The initial license can be downgraded, not the virtualization. You would also have to check the licensing rights for the edition in 2003 to make sure they are the same. Under the Product Use Rights, April 2007, this is what is said;
i) Assigning the Required Number of Licenses to the Server.
After you determine the number of software licenses you need for a server, you must assign that number of software licenses to that server. That server is the licensed server for all of those licenses. You may not assign the same license to more than one server. A hardware partition or blade is considered to be a separate server.
You may reassign a software license, but not on a short-term basis (i.e., not within 90 days of the last assignment). You may reassign a software license sooner if you retire the licensed server due to permanent hardware failure. If you reassign a license, the server to which you reassign the license becomes the new licensed server for that license.
ii) Running Instances of the Server Software.
For each server to which you have assigned the required number of software licenses, you may run on the licensed server, at any one time:
(1) one instance of the server software in the physical operating system environment, and
any number of instances of the server software in virtual operating system environments
So the initial license is the one that is downgraded and then the licensing rights fall under that version.