On the system spec page it states "selectable 720p/1080i/1080p output via HDMI digital interface," so you should be fine with your 720P set. I am assuming that since it has a built in DVD player, it will upconvert your standard DVDs to a higher resolution signal. For you and your TV it would be 720p. That is only if you are using the HDMI output.
The TV will only display the 720p...since that is what it is designed to do. Any other source material will adjust to 720p.
If you are using blu-ray, the player will adjust the video resolution to your TV. The blu-ray is 1080p but will adjust obviously. The receiver should not even touch the blu-ray video signal...should just pass through to the TV.
Also does this HTIB system have the same picture quality as a blue ray player or is this upscaleing something different ?
Upconversion is when a lesser resolution signal is converted to a higher resolution...like a 480p to 720p conversion. Blu-ray has a native resolution of 1080p (no need for video converting).
Should I return my set and get the 1080p model ?
Whether or not you want to exchange your TV for a better model is totally up to you and your wallet. I doubt you will notice a huge difference unless the 1080p model has other special features.
Any specific reason you are looking at this HTiB? How many inputs are on this system...just looking at that back of the unit...doesnt look like there are any...just HDMI, Component, and RCA Video outputs. Is there an additional audio input for another source (blu-ray)?