To make this also apply to Windows XP and older computers, you also need to set the wallpaper in Active Desktop settings.
This is documented in Microsoft KB327998.
To resolve this issue, specify an Active Desktop wallpaper setting in
Group Policy. To do this, follow these steps:
- Click Start, click Run, and then type gpedit.msc.
- Under Local Computer Policy, expand User Configuration, expand Administrative Templates, expand Desktop, and then click Active Desktop.
- Double-click Active Desktop Wallpaper.
- On the Setting tab, click Enabled, type the path to the desktop wallpaper that you want to use, and then click OK.
Active Desktop itself may remain disabled, but the wallpaper also has to be set here in order for Set Desktop Background to not work. Keep in mind that the option won't be grayed out, but will stop working.