Well, I'll concede that the rainbowfaces are definitely interesting, and they're decently entertaining characters even ignoring the elephant in the room. Between the two I prefer the lighter-colored one a bit, she has some good lines.
1.) I consider the reveal at the end to be a point against the movie as a whole - which I must stress that I generally enjoy - and one of the most absurd things to have ever happened in the series. I would have strongly preferred if they executed their departure differently - them just disappearing without any big hurrah would have been a good alternative to the movie's tractor beam(?) exit, and I think that Littlefoot turning back after the distraction to see them sprinting off into the distance and screaming 'Beyond the Mysterious Beyond' as a send-off would have been funny (if not incongruous with the general tone of the characters, I'll gladly admit).
2.) There are two answers I can give here that all coexist inside my head. I'll get the more complicated one out of the way first: this idea is in the context of an old take on the Land Before Time world of mine that I scrapped a few years back that isn't congruent with canon in any way, and had its own modified version of VII that didn't resemble its canon incarnation in every respect; without going into specifics regarding plot, the gist of the idea that the rainbowfaces developed on the same planet and in the same manner as all of the other dinosaurs depicted in the series, but possess human-level intelligence, are even more-well versed than humans in the workings of the cosmos, and have their own cities and technology that reside far beyond the wildernesses depicted in the movies.
In the context of the movies, I just consider them (at least the two depicted in VII) aliens, though I like to think of them as inexplicable alien dinosaurs as opposed to aliens disguised as dinosaurs.
Interesting! Love your headcanon with the advanced rainbowface civilization. Like the dinosauroid concept, but with the advanced dinosaurs living alongside their more primitive counterpart rather than millions of years after the KP extinction event. They'd probably view Littlefoot and the other dinosaurs in the valley much like we view uncontacted tribes today, and probably have pretty strict rules against making contact. Which, indeed, the rainbowfaces repeatedly seem to imply they do. Worth noting though is that Littlefoot and his friends are clearly sapient already, complicating things.
I however quite like the idea of them being a pair of alien shapeshifters. It's weird and corny, but fine for the 7th movie in the franchise. And I quite like the ending too. We're of course not shown the tractor beam, and if you're a kid, the pop culture reference might not be immediately obvious, and it sort of adds to the mystery of the rainbowfaces, who they are and their true motivations.
If we ever get any more LBT films, I'd love to see them make a return someday!