All I can say is what others have - you need to come up with a consensus for your group.
As a way of help, I offer this interpretation of the SRD passage:
A rogue can only sneak attack a living creature with a discernible anatomy.
This obviously refers to creatures such as slimes, oozes, constructs, etc. Even beholders have a discernable anatomy, discernable specifically meaning "one part is able to be determined as different from another part." As long as the creatures has organs, flesh, and a circulatory system that still perform functions, it can be considered as "discernable."
Any creature that is immune to critical hits is also not vulnerable to sneak attacks.
This clause makes the first even clearer, eliminating even undead and animate objects.
The rogue must be able to see the target well enough to pick out a vital spot and must be able to reach a vital spot.
Now the tricky part. The bodies of vertebrates are RIFE with vital spots - most martial arts and military forces will tell you this. The ability to reach a vital in my opinion refers more to creatures that are completely beyond reach with your weapon than creatures who are a few feet taller. Otherwise, as an earlier poster said, Dragons and all huge or colossal creatures are completely immune to critical hits and sneak attacks, because vitals are impossible to reach under most circumstances.
The rogue cannot sneak attack while striking a creature with concealment or striking the limbs of a creature whose vitals are beyond reach.
Concealment applies directly to being able to SEE the vitals, but striking the limbs in my opinion refers to ATTACKING APPENDAGES, in the case of reach and threat range, not that no limbs have vitals, which is not valid to say. See my above comment on the abundance of vitals in a body.
Finally, ask him to examine if he thinks vitals should be unreachable by a halfling. The example of a human attacking a hill giant unless someone corrects me I don't think comes from 3rd edition, I think it comes from 2nd:
...Second, the thief cannot use it on every creature. The victim must be generally humanoid. Part of the skill comes from knowing just where to strike. A thief could backstab an ogre, but he wouldn't be able to do the same to a beholder. The victim must also have a definable back (which leaves out most slimes, jellies, oozes, and the like). Finally, the thief has to be able to reach a significant target area. To backstab a giant, the thief would have to be standing on a ledge or window balcony. Backstabbing him in the ankle just isn't going to be as effective.
- player's handbook, 2nd edition
If a halfling were only able to sneak attack size small or smaller creatures, this makes the most important combat ability of the primary class of halflings unusable, which does not make common sense to me.
