I'm using HTTP Accept headers for content negotiation and serving
"application/xhtml+xml" where possible.

> Well, I'm using xml output method since I'm generating XHTML.

indent=no (which is the default) is your friend then. XSLT2 has an xhtml
output method that does what you want, but I thik you said you were
using xslt1.

Although given that to get the output to render in IE you probably need
to serve it as text/html, it's arguably simpler and more conformant to just
generate html anywway.  If you serve XML syntax as text/html you are
relying on the lax (non existent) error reporting of a typical desktop
browser as for instance using /> syntax on any empty elements in the
head is a syntax error.