They’d probably just buy canonical in this scenario.

How would that affect any of us? Linus Torvalds would still be the lead kernel maintainer, all the other FOSS distros would still exist, and all the people that currently use Linux (out of conviction, out of idealism, out of the FOSS/GNU philosophy) would stick with them, meaning de facto no change whatsoever.

A few things come to mind here.

1. MS tried to ship a renegade JDK with proprietary features, back in the 90's. That didn't go very well for them, as they drew the ire of Sun Microsystems which was a decently sized player at the time. It was a clear licensing issue, and they lost the case. Point being: they're historically not great at this kind of thing.
2. The GPL is designed to thwart this scenario, specifically for things like paid software (e.g. Windows). MS would have to move to a "free Windows software, paid service" model before any of this could happen. But the service must be optional, and they'd have to provide the source to anyone that wants it. That said, they're on track to make Windows free (as in beer), so who knows?
3. Nvidia gets to ship binary Linux drivers, so closed-source binary packages for MS proprietary components on top of Linux might be possible. But again, I don't think they get to charge for that.
4. WRT to drivers/packages, RedHat famously charges for access to their package repository, making automated patching and upgrading a nightmare if you go without. This is one hell of a GPL loophole and worthy of far more corporate exploitation. I can easily see MS following this path.
5. "The net treats censorship as a defect and routes around it." - John Gilmore - (Many) People will just fork away or happily sit somewhere else in the GNU family tree, far from anything MS builds. If the need arises, compatibility layers like WINE will show up eventually.

thats EEE and we are all afraid of that

Microsoft hasn’t changed all that much. They don’t see Linux as an OS to run games or MS Office with. It’s not a consumer platform and never will be, it’s more of a server/container maaybe workstation system for a tech-savvy/developer/scientist. Its UI is meant to open terminals and text editors, not movie players or game launchers. Microsoft loves Linux until it leaves the business area and try to sneak into consumer market. There’s nothing stopping them from doing harm to desktop Linux with all their „love” to Linux the modern mainframe system that happens to be industry standard. They can still patent things and do legality tricks (like in HDMI forums), try to put Windows on devices where Linux could be competition (one Linux handheld console = 10 more new Windows handhelds), bind consumers with something only Windows can run (Xbox Gamepass?) etc

The MS distro you're talking about already exists - it is called Azure Linux (recently renamed from CBL-Mariner).

I doubt this, they have been sticking to Windows

It's called Linspire, what you've described happened 20 years ago. It was not the cataclysmic event you described it as. TBH I'm not that concerned about a company who charges $400+ for an OS that still shows advertisements and loses support after 5 years when I could go out and get an OS with no ads or bloat for free that will never lose support.