I changed your stylesheet so the xsl:output says version="1.0" (there is no XML version 2.0). Then I ran it against the XML sample given in your original message, using Saxon 8.7.3. The result is:
<?xml version="1.0" encoding="UTF-8"?>
<cars>
<model manufacturer="volkswagon">
<name>golf</name>
<name>passat</name>
</model>
<model manufacturer="toyota">
<name>camry</name>
<name>celica</name>
</model>
<model manufacturer="ford">
<name>focus</name>
<name>mustang</name>
</model>
<model manufacturer="honda">
<name>civic</name>
<name>accord</name>
</model>
<model manufacturer="chevrolet">
<name>prizm</name>
<name>corvette</name>
</model>
</cars>
So I don't know what your problem is.
Michael Kay
http://www.saxonica.com/
Author, XSLT Programmer's Reference and XPath 2.0 Programmer's Reference