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From the description of this bug it seems that the problem is not entity references per se (they are OK, as long as DTD that defines them is included), but SYSTEM reference to the XHTML DTD that contains extra space. Epubcheck and Adobe EPUB renderer both key off the DTD URL (which is also given and which is correct) to find XHTML DTD, but WebKit apparently uses SYSTEM ID instead, so it cannot resolve it.
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