modifier-pronoun that

happymanocha wrote:In MGMAT, while explaining the pronouns it is mentioned that "that" should refer to the copy of subject and not the subject itself.

This was mentioned in pronoun chapter under demonstrative pronoun. This rule holds when "that" is acting as a demonstrative pronoun. This is valid to understand the difference between demonstrative pronoun and third person pronoun.

While the example you stated - here "that" is used as a relative pronoun and not a demonstrative pronoun.
The movie THAT we watched last night was scary - Here "that" is acting as a relative pronoun and introduces a relative clause "that we watched" and at the same time refer to "the movie".

There are two simple clause which are joined together.

The other usage of that is as a subordinator where it doesn't refer to any noun - it just introduce a noun clause.

That the GMAT is hard cannot be denied. - here "that" is only introducing a noun clause and not referring to any noun.

Hope this helps !!