Tried this on notepad++ and Chrome, and failure happens each time.  Works OK on other transformation engines.

When setting xml:space='preserve', and then transforming an attribute, the transform fails.  Here's some trivialest-possible demo code - I know that the xml:space attribute won't have any effect in these examples (because there is no text-only whitespace), but at the same time, I'd expect it to transform cleanly, and the transform fails.  (No explanation, I'm afraid: Chrome shows a blank result, and Notepad++ reports that the transformation failed.

This works:

<xsl:template match="@*|node()">
  <xsl:copy>
    <xsl:apply-templates select="@*|node()"/>
  </xsl:copy>
</xsl:template>

This doesn't (says "Unable to apply transformation on current source"):

<xsl:template match="@*|node()" xml:space='preserve'>
  <xsl:copy>
    <xsl:apply-templates select="@*|node()"/>
  </xsl:copy>
</xsl:template>

This does:

<xsl:template match="@*|node()">
  <xsl:copy>
    <xsl:apply-templates select="@*"/>
    <xsl:apply-templates select="node()" xml:space='preserve'/>
  </xsl:copy>
</xsl:template>

This doesn't:

<xsl:template match="@*|node()">
  <xsl:copy>
    <xsl:apply-templates select="@*" xml:space='preserve'/>
    <xsl:apply-templates select="node()"/>
  </xsl:copy>
</xsl:template>

Naturally, to exhibit this bug, the code that's being transformed needs to have some attributes.  If there's no attributes, there's no failure.

More commentary at http://stackoverflow.com/questions/16154092/xmlspace-preserve-doesnt-seem-to-get-on-with-xslapply-templates-select-nod