I have this same problem on 7.04 beta.
Avahi uses the .local as its SOA.  Because you use it internally avahi causes 
conflict.

What should happen is that avahi should warn you that you are using
.local as part of yout fqdn and offer to disable itself in a bubble.

For now, I have changed my internal domain name to .private instead of .local
This doesn't fix the issue that avahi is not warning us about the conflict 
though

-- 
problems resolving fully qualified domain names on Kubuntu feisty
https://launchpad.net/bugs/80900

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