Since PS3 cannot play flac files from its own hard drive the media server has to process the flac file, down-convert and stream it to the PS3.I'm not really familiar with the PS3 in this application, but if it doesn't support FLACs . . . then that's the type of bottleneck that would require the music file to be transcoded or down-converted simply for it to play at all.
The idea behind uPNP is that music files can be transferred between a media server and a "media renderer", and selected by a "control point" . . . and sometimes two or all three of these things are combined in one box. In a Linn DS setup, you have a uPNP media server (usually a dedicated Network Attached Storage appliance), a control point that's used to select your music (i.e. a PDA or laptop running Linn music-browser software), and the Linn DS itself, which is the media renderer. "uPNP" is simply the protocol by which the information is transferred between these three devices, in the same way that "TCP/IP" or "Windows file sharing" is a protocol . . . and have nothing to do with the content of the file itself (as long as nothing is broken and the files arrive intact).
To play FLACs, the media server has to support them because it must be able to read the data tags from the music files and send them to the control point so you can see your collection - but when the file is played, it is transferred whole and unmolested from the media server to the media renderer, which must also support FLAC in order to play it natively. Thus, the ultimate determiner of the sound quality *should* simply be the media renderer.