I want to set up a system for checking damage effects. The projectile hits the player. A cog checks to see whether it does any damage (there is a factor of armor which can potentially deflect bullets, eliminating damage), if it does, spawn blood, otherwise a spark, then run through a formula and apply appropriate damage. However bullets, seem to do damage irrevelant of cog. Is there a way to control the damage of a projectile through kyle.cog? Or should I try setting the projectile to 0 damage, with a class cog which checks the touched message, to evaluate the damage and effects?

You can all handle in the damaged message of kyle.cog. GetSourceRef() returns the projectile (to check for type, etc.), GetParam(0) returns the amount of damage and GetParam(1) the type of damage (explosion, energy, force, etc.).

Will this override the natural damage of the projectile then?

ReturnEx() is used under the damaged message to return the damage amount caused. You can play with the value however you like before finally passing it to the engine to be applied.

I think projectiles do damage as defined in their template.

Yeah, but in the class cog's (for a player, kyle.cog; for an AI, actor_*.cog) damaged message, you can process the damage and apply the result that you want (a constant, such as "ReturnEx(0);", which will result in damaging an amount equat to the constant, in this case zero; or a scaled amount of the damage can be returned, like "ReturnEx(Getparam(0) * 0.75);", which will return 75 percent of the damage (returning 100 percent damage falls under this idea; it would be like "ReturnEx(GetParam(0));" ))

Yeah, as Slaw already stated, the template damage is just passed to the damaged message of said cog as parameters 0 (amount) and 1 (type). If you catch it there, you can do anything you want with it. The damaged message just has to return a value (with ReturnEx()), which will be the final amount of damage (type free) that the engine then applies.
At least, that's what I think.

If you want to get really into details, list the templates of your projectiles/bullets/rockets/ect in kyle.cog, then when damaged, check for the template of the damage thing, and run your special things from there according to what projectile damaged you.