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System and Local Extensions
The files for an extension are located in a folder named by the
extension key. The location of this folder can be either inside
typo3/ or typo3conf/.
The extension must be programmed so that it does automatically detect where it is located and can work from both locations.
Local Extensions
Local extensions are located in the typo3conf/ directory.
This is where to put extensions which are local for a particular
TYPO3 installation. The typo3conf directory is always local, containing
local configuration (e.g. Local), local modules etc.
If you put an extension here it will be available for a single TYPO3
installation only. This is a "per-database" way to install an
extension.
System Extensions
System extensions are located in the typo3/ directory.
This is system default extensions which cannot and should not be updated by the EM. They are distributed with TYPO3 Core source code and generally understood to be a part of the Core system.
Loading Precedence
Local extensions take precedence which means that if an extension
exists both in typo3conf/ and typo3/ the one in typo3conf/
is loaded. This means that extensions are loaded in the
order of priority local-system.