What differences do you see between the permissions on your new file(s) and
the permissions on ItemStyle.xsl? I'd guess that if you match those up
perfectly (perhaps just inheriting  from the permissions of the rest of the
12 hive), you should be good to go.

Then again, upon actually *reading* your post, it looks like you're not
placing these new files  in the 12 hive; any particular reason why not?

The new files  are inheriting  permission from their parent just as the
ItemSyle.xsl is (the same parent).
I added them to the style  library because thats where the originals
were.

So you are recommending I use a feature to deploy the files to
somewhere in the 12 hive? Maybe in the Layouts folder?

That's what I would instinctively recommend, though I haven't attempted this
yet. The ItemStyle.xsl and related files  are located in
12\TEMPLATE\FEATURES\PublishingResources , for what it's worth.

I suspect you have come across a flaw in that technique. What those
guys have done is an "include" in the stylesheet, which is a neat
technique. However, it requires the code that is processing the
stylesheet to load another stylesheet file from the document
library. That code is probably generic XML/XSLT transform code that
wasn't written specifically for SharePoint, and just does an http
get of the stylesheet file.

My guess is that the technique will work in some situations (e.g.
Kerberos authentication with impersonation enabled by default, where
the end user's credentials are available) but not others (e.g. NTLM
authentication, with the two hop authentication issue).

This is just my guess, but based on what I have seen in some other
situations. A workaround would be to locate the included xslt file
somewhere it could be accessed anonymously.