I can reproduce the bug with Xalan 2.2 release. I assume it IS a bug, isn't
it?

You can avoid this by changing the first template:

<xsl:template match="B">
    <xsl:variable name="pos" select="position()"/>
    <xsl:apply-templates select="C">
        <xsl:with-param name="match_number" select="$pos"/>
    </xsl:apply-templates>
</xsl:template>

But such a bug in a release version? We use Xalan for every transformation
in the firm.