Squats are recognized as an important rail track issue related to rolling contact fatigue, and represent a serious problem affecting significant parts of railway networks across the world. The mechanisms of squat initiation and propagation are still a matter of controversy. Research efforts have included understanding of possible relationships between the narrow and brittle white etching layers (WELs) observed on rail surfaces and squat formation in rails. In the present investigation, structural and microstructural features of ex-service damaged rails containing squats and WELs were investigated in order to determine the formation mechanism of white etching layers (WELs) on the rail surface. Synchrotron XRD analysis of rail surfaces, combined with microstructural and microhardness investigations, revealed two distinguishable types of WELs; one characterised by the presence of fine martensite and the other characterised by the presence both of retained austenite and martensite. WELs containing martensite were found to be associated with a deformed subsurface pearlite structure and it was concluded that this type of WEL is induced by severe plastic deformation at wheel-rail interface. In contrast, the WELs containing both of significant amounts of retained austenite and martensite, were associated with the presence of undeformed pearlite in the underlying structure and it was concluded that this type of WEL is either thermally or thermomechanically induced. Synchrotron XRD results obtained from regions of squat defects themselves are consistent to that of WELs containing austenite and martensite in regions near the squats, which indicates a relationship between WELs and squat initiations. Occurrences of cracks extending from WELs down into the rail in squat regions were confirmed by microstructural observations, which is consistent with the premise that cracks in squats originate from an extension of cracks in WELs.