Well i gave the user that ran the app pool, the network service and the user that was in the identity tab on the website every permission except full control and cascaded it, and i deleted the bugnet directory in that folder too and then ran the site and it seemed to create files in there no problem. Im not going to have time to build another machine at the moment to test this on right now but really could be doing with getting it fixed as it is supposed to be our customers bug logging system which has never been working. Literature has already started going out regarding it being in place.
I will do my best to reproduce the issue locally by having the bugnet directory that i have on the live site, in a subdirectory on my local iis with another config file and see if that causes the same. Tho I do need to get this sorted fairly quickly now.