xsl:preserve-space has no effect on nodes in a stylesheet.
For XSLT2 thi sis implicit in that there are separate sections for
stylesheets and source documents, and
http://www.w3.org/TR/xslt20/#stylesheet-stripping
does not mention preserve-space
For XSLT 1 it's expressed a little differently but it does say
For stylesheets, the set of whitespace-preserving element names consists of
just xsl:text.
For source documents, the set of whitespace-preserving element names is
specified by xsl:strip-space and xsl:preserve-space
so again xsl:preserve space has no effect in your example.
David
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