Jeni Tennison
This is covered in the XSLT Recommendation at http://www.w3.org/TR/xslt#section-Embedding-Stylesheets. You can embed a stylesheet within an XML document, but you still need to use the xml-stylesheet processing instruction to *use* it for that document.
Here is a skeletal XML document with an embedded stylesheet that you can expand:
<?xml version="1.0"?>
<?xml-stylesheet type="text/xml" href="#stylesheet"?>
<!DOCTYPE doc [
<!ATTLIST xsl:stylesheet
id ID #REQUIRED>
]>
<doc>
<xsl:stylesheet id="stylesheet"
version="1.0"
xmlns:xsl="http://www.w3.org/1999/XSL/Transform">
<!-- any xsl:import elements -->
<xsl:template match="xsl:stylesheet" />
<!-- rest of your stylesheet -->
</xsl:stylesheet>
<!-- rest of your XML document -->
</doc>
There are two things particularly of note.
Firstly, you have to have a DTD that defines the xsl:stylesheet element as having an 'id' attribute of type ID - otherwise the 'href' pseudo-attribute in the xml-stylesheet processing instruction won't be able to find the stylesheet.
Secondly, you should almost certainly have a template matching xsl:stylesheet that does nothing so that the stylesheet is ignored when it runs - otherwise it will try to run on itself.