Its the OBD (On Board Diagnostics) socket and is used to plug into the ABS or EGR, also shorting out various pins on it makes the fault codes flash up at the warning lamp (well, for ABS anyway). You may find it's replaced the ABS diagnostic plug (blue coloured, 3 pin) that gets mentioned loads in ABS fault threads - it explains why after months of searching on mine (also a '96 (XS) 300 TDi), i couldnt find the blue plug to check my fault codes and had to resort to paperclips in various holes in the OBD socket................
I'm sure a search for 'OBD' on here will bring some more stuff up................