As per the advice of Micheal, I've tried to group records using "preceding" keyword.

Input XML:

<Orders>
<Order>
        <Header>
            <BillId>12345</BillId>
            <Category>Commercial</Category>
            <State>TX</State>
        </Header>
        <Line>
        </Line>
</Order>
<Order>
        <Header>
            <BillId>98765</BillId>
            <Category>Educational</Category>
            <State>CA</State>
        </Header>
        <Line>
        </Line>
</Order>
</Orders>

Desired Output XML::

<Orders>
    <TaxableCA>
        <CategoryType>
            <ProcessingUnit>
                <Category>Educational</Category>
            </ProcessingUnit>

                        <Order>
                              <Header>
                                   <BillId>98765</BillId>
                                   <Category>Educational</Category>
                                   <State>CA</State>
                              </Header>
                              <Line>
                              </Line>
                         </Order>
                 </CategoryType>
    </TaxableCA>

    <Taxable>
        <CategoryType>
            <ProcessingUnit>
                <Category>Commercial</Category>
            </ProcessingUnit>

                        <Order>
                              <Header>
                                   <BillId>12345</BillId>
                                   <Category>Commercial</Category>
                                   <State>TX</State>
                              </Header>
                              <Line>
                              </Line>
                         </Order>
                 </CategoryType>
    </Taxable>
</Orders>


My XSLT:

<?xml version="1.0" encoding="UTF-8"?>
<xsl:stylesheet version="1.0" xmlns:xsl="http://www.w3.org/1999/XSL/Transform">
    <xsl:output method="xml" version="1.0" encoding="UTF-8" indent="yes"/>


    <xsl:variable name="isCA1" select="/*/Order/Header[State[.='CA'] and Category[not(.=preceding::Category)]]"></xsl:variable>
    <xsl:variable name="notCA1" select="/*/Order/Header[State[.='TX'] and Category[not(.=preceding::Category)]]"></xsl:variable>

    <xsl:template match="/*">
        <xsl:copy>


        <TaxableCA>



                    <xsl:for-each select="$isCA1">
                    <CategoryType>
                        <xsl:variable name="categoryname" select="Category"></xsl:variable>
                        <ProcessingUnit>
                            <xsl:copy-of select="$categoryname"></xsl:copy-of>
                        </ProcessingUnit>

                           <xsl:for-each select="/*/Order[(Header/Category=$categoryname) and (Header/State='CA')]">

                                <xsl:copy-of select="."></xsl:copy-of>

                        </xsl:for-each>
                    </CategoryType>
            </xsl:for-each>

        </TaxableCA>

        <Taxable>



                    <xsl:for-each select="$notCA1">
                    <CategoryType>
                        <xsl:variable name="categoryname" select="Category"></xsl:variable>
                        <ProcessingUnit>
                            <xsl:copy-of select="$categoryname"></xsl:copy-of>
                        </ProcessingUnit>

                          <xsl:for-each select="/*/Order[(Header/Category=$categoryname) and (Header/State='TX')]">

                                <xsl:copy-of select="."></xsl:copy-of>

                        </xsl:for-each>
                    </CategoryType>
            </xsl:for-each>

        </Taxable>

        </xsl:copy>
    </xsl:template>
</xsl:stylesheet>



Basically, I am trying to deepen the hierarchy in two levels. 1st Level is according to state (All CA orders to stay in one "TaxableCA" tag and all other states to go under a different "Taxable" tag. Then, underneath each tag, I would like to create another hierarchy node grouped according to the Category type. I.e. all CA commerical orders groups under one tag etc....

When I perform the transformatino, only the first (TX) order is being being up and the resulting XML doesn't have the CA order at all..

Any help would be grealy appreciated..

Thanks

This code:

    <xsl:variable name="isCA1" select="/*/Order/Header[State[.='CA'] and Category[not(.=preceding::Category)]]">

is selecting orders from California provided their category is different from all previous categories. I imagine that what you really want is orders from California provided that their category is different from the categories of all previous California orders. Which would be

select="/*/Order/Header[State[.='CA'] and Category[not(.=preceding::Category[../State='CA'])]]">

Not really an XSLT problem, just an error in your logic...

Michael Kay
http://www.saxonica.com/
Author, XSLT Programmer's Reference and XPath 2.0 Programmer's Reference

Jeepers... Can't believe I overlooked such a stupid and silly mistake..

Having said so, do you think there is any other better (efficiency) way of executing this data transformation?

Thanks for all your help.

Well, it's a standard grouping problem, so the choices are

* xsl:for-each-group in XSLT 2.0

* Muenchian grouping in XSLT 1.0
  - see http://www.jenitennison.com/xslt/grouping



Michael Kay
http://www.saxonica.com/
Author, XSLT Programmer's Reference and XPath 2.0 Programmer's Reference