Is it permissible to use a piece of edited official subeta art for a pet overlay (not the CSC overlay but just a regular CSS one)?
For example if I wanted to use
but recolored, would this be allowed if I give credit for the base image?

your best bet is to file a ticket and ask staff. As users we can't interpret the rules for you. If we're wrong, if we give the wrong advice, you're the one to pay the price.
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If you have a question about the rules for overlays, please file a support ticket!