From my initial post i have read a lot more into this.
Google used to give more weight to internal links from subdomains than directory pages, however this has changed so it doesn't matter which you do.
However, for large sites there is some advantages to using subdomains. In G serps each website is only allowed 2 places in the serp. G will index each subdomain as a separate "website", so buy using subdomains you can achieve more than 2 places in the serps.
If you had a massive network of sites that were all interlinking, G will see this as "spamming" (black hat seo). However you would need to have a very large network where all the sites interlinked.
Please note that the above two comments are my summary of info i have read accross many forums, so if anyone would like to add anything or correct me then please do!
-Ben