My Time Capsule has all applications (like Mail, etc.) backed up from Snow Leopard. What happens to my backup when I upgrade to Lion? Will it replace the old Mail with the new Mail? Will there be any issues?
As I said, it will work exactly the same way. So yes, there will be an old version of Mail, and any other application or file that you've changed, until space is needed for more backups. Remember, it simply starts deleting old backups when it runs out of space, so you're not really losing anything by letting it keep those for a while.