From everything I've read the ATI theater mode will only work in Vista/Win7 with Overlay video mode, not with EVR or VMR7/9. All things point to it being disabled for DRM reasons (go figure). I have also read that if your secondary display is an LCD TV connected via HDMI/DVI (i.e. another monitor in Window's eyes) this may not be an issue - I cannot confirm this.
The only solution i've found for regaining the theater mode functionality you might have enjoyed in XP via components (RGB, Scart, S-Video etc) is:
"You need a video player that can use Overlay, like Media Player Classic, though Vista auto switches to Basic theme when video plays fullscreen on 2nd display". Also, failing that, in the same vain, I found this:
"Easy way to do it is download Media player classic homecinema, do a search to find the executible file and right click properties -> compatibility. Tick the bottom two options (disable desktop composition & display scaling) and save. Afterwards set it as your default player and open a video file, windows will switch to the basic theme and you will get perfect theater mode on your second monitor/tv."