Just a question amit:

How do you create an AJAX enabled site, because I don't see that option in VS 2008? I only see ASP.NET web site and AJAX server control project. Not AJAX project, neither AJAX enabled site. 

 well that options was for those using 2.0 , in 3.5 they have removed this option and have provided in built ajax support

 ok, thanks!

I'm having the same problem as fpih. I'm using a .NET 1.1 application converted to .NET 3.5. I've checked all of the web.config settings and I'm still getting a full page postback.

 I've also checked and reset all of my browser settings. It shouldn't be the browser because, update panel works when I create a new project. Is there other settings I should look at?

 I've solved my problem.

 There was an xhtmlConformance element which was set to Legacy. I changed it to Transitional and the update panel worked as expected.

Note to anyone who previously converted from a .NET 1.1 web application: if your using ajax and update panel is causing a full page post back. Check for the xhtmlConformance element in the web.config