Does Windows Virtual PC support virtual applications with an XP Home Edition guest?

"You might not have the right version of virtual machine additions installed in the guest.

If that's the case, I suggest that you uninstall the old version and reboot the guest before installing the new version.

EDIT

Since the above is not the case,
the problem is actually that the guest is Home edition, and does not have a Terminal Server. Hence, the error that it cannot enable integration features.

For integration Features to work, the guest OS should allow Remote Desktop, and hence have a TS server. Unfortunately, XP Home doesn't have Remote Desktop.

From Disabling Integrated Mode in Windows Virtual PC :

You can permanently disable integrated mode by disabling integration features under the virtual machine settings:

I haven't tried this, but the screen above also mentions the clipboard. If you lose clipboard integration, the cure might be worse than the disease."