Internal Level, as I understand it, is like the background level.
Say, you have a unit who is a level 18 Hero. Assume they were a level 1 mercenary when you got them, and got them to level 20 before promoting them to Hero.
So, their actual level is 38 (20 from Mercenary, 18 from Hero), even if only "18" is shown. So, if you use, say, a second seal and become a Paladin, and then to level 5, you are actually level 43 (20 Mercenary, 18 Hero, then 5 as Paladin). I don't think there is a cap, but the amount of EXP you start to get slows down considerably.
I could be wrong, though. That is just how I understand it.