No, Windows XP cannot be used as a "domain server". A domain server is generally called a domain controller. It controls the domain. This is usually used within an organisation which is reasonably large. It supplys the ability to authenticate users to specific services, such as authentication to a SQL service. One of the nicest functionalities is groups. You can create a group, say "G1". You can then create a share that gives G1 full control on the share. Now you create another share. Again you give G1 full control. Now imagine a Workgroup environment. These shares would be created with Workgroup as either everyone has full access, or everyone has restricted access. Now your accountant has some very important info in an Excel file that he updates weekly, and the MD want's to be able to read it. Workgroup sharing, means if he shares it, everyone can see it. Even if it is only read only at the best. But with a domain, you can restrict everyone from seeing the document, except the MD and the accountant. This is best accomplished by adding these two people to a group, and giving the group access. This way, if they have 30 shares that both of them access, then if they decide to add a new person to have viewing priveleges, you merely add them to the group, as opposed to finding each share and changing it individually.
But basically in short. For a Windows Domain Controller, you need Windows Server 2000/2003. You can use Linux, but it does lack a few of the features, such as true ADS. Get hold of a company that sells Windows Server, and ask them to "sell" it too you, so you can see it's benefits, compared to a Workgroup setup