We did, although we didn't associate a product with both the category and the sub-category, just the sub-category.
After further testing, I can see we should update this.
The issue still stands though, as when you're on the landing page for the Category 2 items and select either a sub-category or the parent of Category 1, you still receive a null result.
From what I can see, having tried different settings, this appears to be as a result of the 'Buy Now Page' as defined in the Category module settings, which suggests the Category Module is only useful for displaying sub categories for a single parent. I think.
If so, how can we display categories and sub categories throughout the site when they have different parents?