Comment 1 for bug 673114

This depends on whether or not it can find a "diff" program to run. If you have one it passes, if you don't it fails. Regardless of the standalone installer or not.

What is really weird is that on my machine I get:
$ bzr selftest -s bb.test_diff.TestExternalDiff
bzr selftest: C:/Users/jameinel/dev/bzr/bzr.dev/bzr
   C:\Users\jameinel\dev\bzr\bzr.dev\bzrlib
   bzr-2.3.0dev4 python-2.6.4 Windows-Vista-6.0.6002-SP2

----------------------------------------------------------------------
Ran 2 tests in 4.352s

OK
Missing feature 'diff executable' skipped 1 tests.

Which says that it does check for "diff" being runnable and skips the test. So the real question is why does it think you have a 'diff' that it can run, but it fails to run it.