Report Builder does not connect for a remote reporting Server
After a lot of digging around, I didn’t get anywhere, then eventually I got Microsoft involved to help me with the problem. 

MS solution architect confirmed that the Report Builder requires a direct connection to SQL Server when launched hence the working with data sets in the report builder failed. Apparently this is BY DESIGN and it is not going to change. 

This was in SQL Server 2008 R2 but the same is true for SQL Server 2012, 2014 and 2016. Not sure about 2017 but I doubt it very much if that has changed in 2017. 

We ended up providing the client a machine on the network in DMZ to which end users connected remotely, only to work with the Report builder, it is a poor solution but it worked at that time and we needed a quick fix for it at that time.