This straight from MSDN:

Will MSXML support XSLT 2.0?

No. MSXML versions 4.0 and later fully implement and support XSL Transformations (XSLT) Version 1.0 (W3C Recommendation 16 November 1999). If your XML application requires a later version of XSLT, Microsoft strongly recommends moving to the newer System.Xml framework classes, because all future XML development efforts will be focused there.

MSXML here refers to all versions of MSXML in IE as the latest version when invoked with something like:

var xml = new ActiveXObject("Microsoft.XMLDOM")

Apparently even MSXML 3.0 (IE6+) doesn't support XSLT 2.0 much to my disappointment.  Ok, so what is System.Xml all about, and is it applicable to Internet Explorer?