I made minor modifications to your script, and it works fine for me on 10.6.7. (System Events groks file extensions better than the Finder these days.)
(* Set Lable Index colours of selected files to defaults *)
set fileColorList to {red:{"app", "scpt", "bin", "pl", "py", "sh"}, orange:{"zip", "mpkg", "pkg", "tgz", "gz", "dmg", "torrent", "iso", "tar"}, yellow:{"xml", "xpi", "html", "htm", "PrefPane"}, green:{"aa", "m3u", "mp3", "mp4", "mov", "xspf", "qt", "aif", "aiff"}, blue:{"epub", "pdf", "txt", "rtf", "asc", "ascii", "djvu", "old"}, purple:{"pages", "numbers", "keynote", "doc", "xls", "nbp", "csv", "ics", "ppt", "pps"}, grey:{"png", "jpg", "jpeg", "gif", "tif", "tiff", "psd"}}
set theseFiles to choose file with multiple selections allowed
repeat with myFile in theseFiles
tell application "System Events" to set fileExt to name extension of myFile
tell application "Finder"
if fileExt is in orange of fileColorList then
set label index of myFile to 1
else if fileExt is in red of fileColorList then
set label index of myFile to 2
else if fileExt is in yellow of fileColorList then
set label index of myFile to 3
else if fileExt is in blue of fileColorList then
set label index of myFile to 4
else if fileExt is in purple of fileColorList then
set label index of myFile to 5
else if fileExt is in green of fileColorList then
set label index of myFile to 6
else if fileExt is in grey of fileColorList then
set label index of myFile to 7
end if
end tell
end repeat
BTW: I wouldn't run this using a 'choose file' dialog; I'd use FastScripts and bind it to a Finder-specific keyboard shortcut. And in fact I have a couple of scripts which do just that. It's simpler and faster (for me).