Ooops - sorry yes the codeSubDirectories do indeed live under compilation - sorry for adding to the confusion (I really need my specs on when I reading these xml docs).
I do hope my point about the /configuration/location/system.web still stands though as it is a technically valid (although incorrect for dnn) web.config and could cause the above error.
Just to reiteratate - this only affects the installation, not the running of the IFrame - which is now installed and quite happy, the other workaround I have seen is to modify the .dnn file to change the [app_code] sections to the full relative path.