Thank you very much for your reply, I have spent some time playing around with the files now and although that wasn't quite what I was looking for I realised that it could be a work around.
After adding the transparent parameter, removing the background from the swf and setting the two IDs to different z layers it appeared to be working. Unfortunately the z layers (or maybe position absolute?) seems to affect the swf and double clicking no longer enlarges the images 
HTML Code:
<img src="background.jpg" alt="my background" id="background_image">
<div id="fullscreendemo">
<strong>This site requires Flash Player 8.0 or greater</strong><br />
Please click <a href="http://www.adobe.com/products/flashplayer/">here</a> to download.<br />
If you are sure you have the required version, press this link: <a href="readme.html?detectflash=false">bypass the detection</a>.
</div>
<script type="text/javascript">
//<![CDATA[
var so = new SWFObject("polaroid.swf", "polaroid", "100%", "100%", "8", "#FFFFFF");
// specify the url to the xml-file, default is photos.xml
so.addVariable("xmlURL","photos.xml");
so.addParam("wmode","transparent");
so.write("fullscreendemo");
//]]>
</script>
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