OK, Got it working, thanks for the helpful input guys.
It seems like the behavior file was actually being found (man I hate IE developer tools - gimme be webkit inspector or firebug anyday), but for some reason ( which I don’t understand at this point) the element this behavior is applied to must have position:relative set.
Anyway, the result is simply brilliant. I can now use CSS3 features such as box-shadow and rounded corners and have them render in all browsers including IE6 upwards. No more screwing around with background images, man this is such a simple way to lay out pages. (Bring on full CSS3 support).
Sure there is a little extra overhead with the behavior file, but hey, I lose some overhead with fewer background images etc too, so thats a good trade-off.