muhith,
you're spending a lot of time and effort on a project that doesn't make much sense to me. First of all, Kanotix is designed for hd install. This is the only way you can dist-upgrade and install the latest kernel. Secondly, it is much more convenient to put the iso file on the internal hard drive and use a separate partition or a thumb drive for your persistent home directory. You can either boot the computer off the LiveCD with cheat code "fromiso" or save grub to MBR. There's a section on this in the Kanotix FAQ, you can even put the unionrw directory inside your home directory so as to reduce the number of directories.
Finally, the partition on which the bootable iso file is located is mounted read only. So you need at least two partitions if you want to save data such as a persistent home directory.