Hanu, I agree with you that simple past is what sounds more natural here with your example : 'When they gave their book to the teacher, she allowed them to play outside'. The point here with the word 'WHEN' is that both actions took place at the same time so it makes sense that the tense is the same for both clauses. Now it would have been different with the word 'AFTER' I believe, and then you could have said : 'After they had given their book to the teacher, she allowed them to play outside'.
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