Test stylesheet:

<xsl:stylesheet version="2.0"
                xmlns:xsl="http://www.w3.org/1999/XSL/Transform">

  <xsl:function name="foo">
    <xsl:param name="bar"/>
    <xsl:sequence select="''"/>
  </xsl:function>

  <xsl:template match="/">
    <p>it works!</p>
  </xsl:template>
</xsl:stylesheet>

Expected output using xsltproc: 

<?xml version="1.0"?>
<p>it works</p>

Actual output using xsltproc:

...
compilation error: file /tmp/test.xsl line 5 element param
element param only allowed within a template, variable or param
...

transform aborts

The spec is very clear:

"If an element is processed in forwards-compatible mode, then:

    if it is a top-level element and XSLT 1.0 does not allow such elements as top-level elements, then the element must be ignored along with its content;"

-- https://www.w3.org/TR/xslt#forwards