I apologize for this not being a 6g topic but am kinda stuck as to what to do so any productive info will be appreciated. Anyway, here's the story:

My dad owns a 1992 Suburu Legacy GT with something like 350,000kms on the clock. Recently the ignition has started being retarded and upon moving the knock sensor to a new location has reduced the problem. Another factor that reduced the problem was using a higher octane fuel. Does anyone know how to fix this problem or even bypass the knock sensor? Removing the knock sensor enirely doesn't work. Also he is running a twin WRX chipset system (however that works).

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i dont know much about subaru, but that looks like the cause of your problems right there.

you do not want to remove the knock sensor. it is there to protect your motor. without it, the engine will detonate and fail.

Instead of trying to band aid the problem, you need to find out why your experiencing spark knock, detonation, pre-ignition, whatever you want to call it. Possible causes of knock:
http://www.misterfixit.com/deton.htm

Google search engine knock, you'll get thousands of hits.

Most likely he may need to freshen up his ignition componets.