Win XP SP3
As I pointed out above I installed 1.7.1 using a 7zip self extracting archive xampp-win32-1.7.1.exe and opened it with WinRAR and extracted the xampp folder to the root folder of my drive G: so I had G:\xampp171 then ran the setup_xampp.bat file.
It installed without issues.
I ticked the Svc box and installed MySQL as a service and then started MySQL.
Absolutely no problems.
SCM revealed MySQL as having the Path to executable as:
"G:\xampp171\mysql\bin\mysqld.exe" --defaults-file="G:\xampp171\mysql\bin\my.ini" MySQL
No mention of a my.cnf at all.
Next I renamed my.ini to my.cnf which created my that looks like a shortcut and dragged it into my text editor and sure enough it was called my.cnf.
To have the file read again I Stop MySQL and uninstalled the service and reinstalled the service then Start MySQL and the Path to exe again showed my.ini in the SCM.
So I can't replicate your issue with the my.cnf in the path to exe in the SCM which incidentally is located in the registry and will always remain the same every time you install and uninstall the MySQL service. So it must be compiled that way, who knows.
Registry value can be found here using regedit:
leave regedit open and then uninstall the service and then click on View in regedit and the Refresh and make sure the above key is deleted - repeat after installing the MySQL service again to check that the key is again created - this way you will know if the registry key is actually coming from XAMPP 1.7.1 and not from an old installation of XAMPP.
Time in my opinion for you to back up your files and uninstall 1.7.1 (which if I recall was a bit of a beastly release) and install 1.7.7 unless of course you files need older XAMPP components, in which case 1.7.3 was quite stable and relatively bug free.
Older versions can be found here:SourceForge XAMPP File Repository
There is no upgrade from 1.7.1 to 1.7.3 only 1.7.1 to 1.7.2 which might be an a;alternative if your not concerned about versions.
Sorry best I can do for your issue also I know nothing about Windows Servers File Systems or how they interact with mostly unproblematic applications in other Windows Operating Systems.