This looks to me like a simple case of LyX not recognizing that a path which starts with a drive letter specification ("c:/") is an absolute path and not a relative one.
Could you try without the drive letter, that is setting the target to "/lyxfiles/thesis/ch3.tex"?
The solution! If i just remove the "c:/" i can include files from anywhere.
Many thanks to everyone for their help.
And yes I can't spell arguement(sic)
