There needs to be a definition of the xsi namespace. E.g.
<ShowVehicleRemarketing
  environment="Production"
  lang="en-CA"
  release="8.1-Lite"
  xmlns:xsi="http://www.w3.org/2001/XMLSchema-instance"
  xsi:schemaLocation="http://www.starstandards.org/STAR/STAR/Rev4.2.4/BODs/Standalone/ShowVehicleRemarketing.xsd"
>
Update: You could write a user defined filter and then let the XMLReader use that filter, something like:
stream_filter_register('darn', 'DarnFilter');
$src = 'php://filter/read=darn/resource=compress.zlib://something.xml.gz';
$reader->open($src);
The contents read by the compress.zlib wrapper is then "routed" through the DarnFilter which has to find the (first) location where it can insert the xmlns:xsi declaration. But this is quite messy and will take some afford to do it right (e.g. theoretically bucket A could contain xs, bucket B i:schem and bucket C aLocation=")
Update 2: here's an ad-hoc example of a filter in php that inserts the xsi namespace declaration. Mostly untested (worked with the one test I ran ;-) ) and undocumented. Take it as a proof-of-concept not production-code.
<?php
stream_filter_register('darn', 'DarnFilter');
$src = 'php://filter/read=darn/resource=compress.zlib://d:/test.xml.gz';
$r = new XMLReader;
$r->open($src);
while($r->read()) {
  echo '.';
}
class DarnFilter extends php_user_filter {
  protected $buffer='';
  protected $status = PSFS_FEED_ME;
  public function filter($in, $out, &$consumed, $closing)
  {
    while ( $bucket = stream_bucket_make_writeable($in) ) {
      $consumed += $bucket->datalen;
      if ( PSFS_PASS_ON == $this->status ) {
        // we're already done, just copy the content
        stream_bucket_append($out, $bucket);
      }
      else {
        $this->buffer .= $bucket->data;
        if ( $this->foo() ) {
          // first element found
          // send the current buffer          
          $bucket->data = $this->buffer;
          $bucket->datalen = strlen($bucket->data);
          stream_bucket_append($out, $bucket);
          $this->buffer = null;
          // no need for further processing
          $this->status = PSFS_PASS_ON;
        }
      }
    }
    return $this->status;
  }
  /* looks for the first (root) element in $this->buffer
  *  if it doesn't contain a xsi namespace decl inserts it
  */
  protected function foo() {
    $rc = false;
    if ( preg_match('!<([^?>\s]+)\s?([^>]*)>!', $this->buffer, $m, PREG_OFFSET_CAPTURE) ) {
      $rc = true;
      if ( false===strpos($m[2][0], 'xmlns:xsi') ) {
        echo ' inserting xsi decl ';
        $in = '<'.$m[1][0]
          . ' xmlns:xsi="http://www.w3.org/2001/XMLSchema-instance" '
          . $m[2][0] . '>';    
        $this->buffer = substr($this->buffer, 0, $m[0][1])
          . $in
          . substr($this->buffer, $m[0][1] + strlen($m[0][0]));
      }
    }
    return $rc;
  }
}
Update 3: And here's an ad-hoc solution written in C#
XmlNamespaceManager nsmgr = new XmlNamespaceManager(new NameTable());
// prime the XMLReader with the xsi namespace
nsmgr.AddNamespace("xsi", "http://www.w3.org/2001/XMLSchema-instance");
using ( XmlReader reader = XmlTextReader.Create(
  new GZipStream(new FileStream(@"\test.xml.gz", FileMode.Open, FileAccess.Read), CompressionMode.Decompress),
  new XmlReaderSettings(),
  new XmlParserContext(null, nsmgr, null, XmlSpace.None)
)) {
  while (reader.Read())
  {
    System.Console.Write('.');
  }
}