<!-- Using a combination of NeverOverwrite and KeyPath, you can avoid overwriting files on update -->
<Component Id="C.ServiceConfig" Guid="151fbb78-9331-4fe6-aa01-bfaea9368e95" NeverOverwrite="yes">
    <File Id="Fi.ServiceConfig" KeyPath="yes" Source="$(var.Service.TargetDir)\Service.config" />
</Component>

To make sure a config file is not overwritten on an update, make sure the NeverOverwrite attribute on the Component is set to yes.