The contenders fielded questions from a special BBC Question Time audience in Oldham, chaired by David Dimbleby.
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Key issues discussed on the show included Brexit – with Smith arguing Labour should stop the United Kingdom leaving the European Union by using a second referendum or an election, while Jeremy Corbyn said he thought it was possible for Britain to leave but to stay in the single market.
The head-to-head came just weeks before voting in the race closes, with the victor to be named on 24 September.
Current Labour Party leader Jeremy Corbyn enjoys strong support from many party members but doesn’t command the confidence of the majority of his MPs, losing a vote of no confidence by 172 to 40 in June.
Jeremy Corbyn and Owen Smith have been told that Labour’s bitter election contest has made them both look “unelectable” and they should step aside for another candidate, as the pair clashed in a series of tetchy exchanges.
The audience was made up of Labour voters split between the two contenders and members of other political parties.
The Labour leader has no support from his MPs and his challenger has no support from the party, they were told.
“I think some of the people around Jeremy are absolutely encouraging it, of that I have no doubt”, he continued.
The TV debate came after Ed Balls lambasted Mr Corbyn, claiming he doesn’t actually want to win an election and become Prime Minister.
Mr Smith told the audience he was “incredibly confident” he would be victorious in late September.
On the BBC’s Daily Politics, he said: “The thing that worries me is I fear that Labour at the moment is becoming a party around Jeremy Corbyn which thinks strengthening its base in opposition is sufficient”.
His comments come after his aides suggested on Wednesday that he might rule out full membership of the single market unless the United Kingdom could negotiate exemptions from key European Union rules.
Asked if that meant to ignore the Brexit vote, he replied: “Well, exactly”.
He claimed there was a “hard left infiltration” of Labour and that some were “bringing in to our party anti-Semitic attitudes”.
He proceeded to repeat the words “what I said was” three times, while attempting to explain “the chances are we’d never be able to negotiate with Islamic State”.
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Corbyn hit back, criticising Smith’s attacks as unfair.
