I have documented how I resolved this issue on my blog: 
http://brtknr.com/2017/03/15/permission-issues-with-xpra-on-ubuntu-16-04-when-tunnelling-through-SSH/

Turns out that the version of xpra (0.15.x) provided with Ubuntu 16.04
is not supported anymore and updating to 2.0.x resolved the issue.

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https://bugs.launchpad.net/bugs/1589447

Title:
  Xdummy cannot be used in Xenial

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