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The SourceSafe action ultimately invokes the VSS command-line tool (ss.exe) to perform the actual operation. You can check the 'show command-line' checkbox on the last tab and build to see the command-line it generates.
The recursive (-R) switch has no effect for a VSS Label operation. A project label in VSS is simply a file with a timestamp, so I'm not sure why VSS would be prompting about replacing labels, unless it is doing some check and those sub-projects have been previously labeled with that label. The info from the command-line being used should be enough to submit a support question to MS about the behavior you're experiecing if it is unexpected.
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