Hey @bk ,
Based on the error msg; it seems that the VM on which the Self hosted IR is installed is not able to access the SQL MI database.
For that to verify, login into the VM hosting the IR and try to execute the below cmd in cmd line :
ping <<IP address of the SQL MI server>>
Note: The IP address should be the private IP of the SQL MI server since both the VMs are in the same Vnet.
Else , install SSMS/Azure data studio in the VM with IR and try connecting the SQL MI.
If we are not able to access SQL MI, then that is the reason why Linked service is not being created and you would need to make some network security changes across the 2 VMs for them to be able to communicate.