The correct sentence is "They knew that it was she who created the beautiful painting," because the pronoun 'she' is used as a subject of the clause. You cannot use 'her' as a subject; it is usually used as a possessive pronoun. The clause "it was she who created the beautiful painting" is grammatically correct because 'was' serves as the linking verb, making IT and SHE equal. So, if you are going to rephrase the sentence it would be 'She was the one who created the beautiful painting' and not 'Her was the one who created the beautiful painting'.
