If we are going to cite regs, let's at least cite them correctly.  The FAR's themselves (which are the only true "regs" on the subject) simply state that persons not essential to the mission cannot be carried during the test period.  In interpreting this reg, the advisory circular makes two statements:

1.  "The carrying of passengers will not be permitted WHILE THE AIRCRAFT IS RESTRICTED TO THE FLIGHT TEST AREA"; and

2.  "Flight instruction will not be allowed in the aircraft WHILE CONDUCTING FLIGHT TESTS."

Those of you who read carefully will notice a difference in language in the two provisions.

The first provision is consistent with the FAR because "passengers" are, by definition, not essential to the mission.  A pilot receiving flight instruction is not a passenger.

The second provision makes the common sense point that the aircraft cannot be used simultaneously to provide instruction and to conduct flight tests.  Good idea!  It doesn't take a genius to figure out that the first stall series done in a new experimental aircraft should probably not be undertaken by a pilot with no experience in the aircraft.

Incidentally, flight tests are specifically mandated by the circular and applicable FAA guidelines and, at the end of the test period, the pilot must certify in the log book that they have been accomplished.  Nothing in any publication that I know of says that the flight tests must take up the entire 25 or 40 hour test period.

It seems unlikely to me that the use of the different language in the two provisions was simply drafting sloppiness.  My assumption is that the language was intended to mean what it plainly says:  you can't have people that are just along for the ride and you can't train a new pilot at the same time that you are doing flight tests.

Incidently, for whoever suggested that it is permissable under the advisory circular guidelines to take someone to observe engine guages, the "passenger" provision strongly suggests otherwise.

I have no doubt that there are FAA inspectors that take a more restrictive view.  It would not be the first time that a local FSDO exceeded its statutory authority.  That may be a possibility worth considering.  However, I have very little doubt that a court would find that flight training is not prohibited during the test period (except while conducting flight tests) based on the FAR and with all due consideration for the Advisory Circular.