While installing domain controller on windows server 2003 using the iso in the LAB and i got the error message.
I tried with multiple iso’s thinking that it could be issue with iso but it gave the same error for all the iso.
Checked the current windows version and it was running.
Installed SP1 on R2 and rebooted the base machine.
Now creating the LAB virtual machine and now it’s working fine without any error.
Moral of the story, you can’t create virtual machine on Windows 2008 R2 host. It has to be with SP1.