It's transparently obvious that the reason China wants control of the source code for their People's Revolutionary Operating System is because it's a totalitarian regime with a vested interest in maintaining the ideological purity of the information sent and received by its comrade citizens.
Without a primary source for the "Chinese audited XP's source code and deemed it crap" quote, I call shenanigans (aka wishful thinking on the part of a Linux advocate).
If true (which I doubt), I think it's more likely they tried and failed to get the source code, but saving face is very important to the Chinese, so there you go.
ETA: Well, fuck me dead. MS actually did grant the Chinese gubmint (and others) some access to Windows source code:
http://www.microsoft...28gspchinapr.aspx
...back in '03.
OTOH, I'm not sure what's exciting about Kylin, as it's just a heavily localised version of Ubuntu. Baidu instead of Google! Chinese input methods! Comprehensive support for The Great Firewall! Automatic reporting of Ideologically Incompatible Material! Etc.