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They know that we can't break this, that's why they gave it to us.
They Knew that we can't break this, that's why they gave it to us.

Which one is correct? I know, knew is past tense of know but I'm confused in this context.

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Your last clause specifies that they gave it to us in the past; and they had to know in the past, too, that we would be unable to break it, since that is why they did so.

However, that knowledge could very easily extend into the present and future, as could our inability to break it.

So either of your examples could be appropriate, depending on context; so could another possibility, with both KNOW and CAN in past form. Putting time references in should make the differences clearer.

They know now (and knew at the time when they gave it to us) that we can't break this now (or at any future time that matters); that's why they gave it to us.

They knew when they gave it to us (recently) that we can't break this now (or at any future time that matters); that's why they gave it to us.

OR

They knew back when they gave it to us that we couldn't break this at that time (or at any subsequent time that mattered); that's why they gave it to us.

Which is correct will depend on what you mean.

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    That's doubtless all true - but in practice, if what they knew was really "true", it still is, and they can still know it. And hardly anyone would actually bother to distinguish the potential nuance of talking about what they knew in the past (as opposed to still know) unless they had in fact been mistaken. In which case you'd obviously say "They thought we couldn't break it - but of course we did". – FumbleFingers Apr 29 '13 at 2:14

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