To cut a long story short, if you install SQL Server 2008 R2 via ISO mount in Virtual PC, the install will fail with a Database Engine Handle error.

To get out of this issue:

• Uninstall everything to do with SQL Server (from Programs and Features)
• Extract the ISO to a folder using WinRAR (do not use WinZIP, I've found articles suggesting that WinZIP doesn't extract the files correctly - no doubt the same issue that Virtual PC has)
• Install from the extracted folder instead