It seems XSD.exe doesn’t seem to recognize
OR ... sweet way would be to look at XSDObjectGen tool. This is pretty exhaustive and can handle imports/mutiple xsd files easily. (though one level down). This code can then be used as a class exposed by web services.
Download Sample Code generator from here - http://www.microsoft.com/downloads/details.aspx?familyid=89e6b1e5-f66c-4a4d-933b-46222bb01eb0&displaylang=en
Saves lot of time and pain for sure! HTH, Thanks - Dipesh