The Rebbe's explanation of whether the tzimtzum — the "contraction" of G-d's infinite light before creation — is to be understood literally:
The views and Chabad's position. There are several historical approaches to the tzimtzum; Chabad follows the view that it is not literal, and that it is only in the light and not in its Source (IK 11). On the difference between the views of the Ramak and the Arizal, see IK 7109. G-d's ability to contract Himself does not contradict the command to know Him, nor the continuous creation of the world (IK 10216); on how the light exists within its Source, and the view of those who take the tzimtzum literally, see IK 7465, 503.
The Vilna Gaon and Rabbi Chaim of Volozhin. The Vilna Gaon understood the tzimtzum literally (end of his commentary on Sifra DiTzniusa), and this was among the issues over which the Chassidim were persecuted in his lifetime, as the Alter Rebbe's letter in Beis Rebbe states even more explicitly (IK 10227, 551). His disciple Rabbi Chaim of Volozhin explained it as not literal (Nefesh HaChaim 3:7), departing on this from his teacher (IK 551, 11).
Its practical meaning. The question bears directly on Divine Providence: the Baal Shem Tov's teaching that Hashgachah Pratis extends to every detail of creation is tied to the continuous creation that follows from the tzimtzum not being literal (IK 94).
See also: Kabbalah – Authority of the Arizal's teachings; Faith and Chassidus – Free will, Divine Providence and miracles; Faith and Chassidus – Chassidus (general).