When launching node on remote machine, is the local or remote version of the package used?

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What roslaunch really does is start a client roslaunch on PC 2 (using SSH), which is then used by the master roslaunch server on PC 1 to start nodes on PC 2, but those binaries will need to be present on PC 2 (they don't get up or downloaded by anyone in this setup).

So in your words: PC 2 will "use the code from PC 2".

See also wiki/roslaunch/Architecture - Remote Processes for some details about how this works.

Edit: I've seen setups which worked around this limitation by using NFS (or a similar remote FS) to export a workspace that was then shared by all hosts. In this way all hosts would start the exact same nodes, but of course this comes with its own difficulties.