Need to see what your XML looks like.
I suspect the problem is that your source XML doesn't contain html tags at all.
Perhaps it contains something like this:
<para><![CDATA[<b>text</b>]]></para>
or this:
<para><b>text</b></para>
Both of these notations are saying "this stuff might look like markup, but it isn't, and I don't want it treated as such". And surprise, the XSLT then treats it as ordinary text, not as markup.
Michael Kay
http://www.saxonica.com/
Author, XSLT Programmer's Reference and XPath 2.0 Programmer's Reference