A "system" is a single physical or virtual computer.
The limit of 4095 host CPUs indicates that Xen can take full advantage of a physical host system with up to 4095 CPU cores. But, if you had a (theoretical) 8192-core server, Xen could use only half of those CPU cores.
The guest CPU limitation applies to virtual machines. If you have a server with 1024 cores, you can assign only 512 of them to any single virtual machine.
What does this really mean, in 2012? If you are working with typical commercially available server hardware, you will not have the opportunity to reach these limits. So, why are these limits important? Because other popular hypervisors have CPU limits that are far smaller. For example, Hyper-V R2 allows only 4 virtual CPUs per guest operating system, and even vSphere 5 allows only 32.