In my opinion, this is a complicated topic.
Sometimes turning up the hardware volume increases the noise you hear if you play silence (use Tools > Advanced Tools > Create Test Clips to generate silence files to test with).
If turning up the hardware volume causes you to hear more noise, it makes sense to not turn up that volume more than necessary.
But many times, turning up the hardware volume makes no difference to the noise in a stream of silence. So in these cases, maximize that volume and use Internal Volume so that Media Center has as much headroom as possible.
I test this by putting my ear right next to the speaker and adjust the volume while silence plays. With my Creative X-Fi hooked to a power amplifier, and also several more traditional Sony receivers I've tested, the hardware volume made no difference to the noise on the output. I don't know the deciding factor in this, but would like to.
So in those cases, Internal Volume should provide the best sound quality, especially if you do processing like Room Correction, Bass Management, Convolution, Linkwitz, etc. with Media Center where the extra headroom is useful.