Had the same issue.

• download asp ajax toolkit 3.5 ( you will notice it shows 3.5.0.4 and talks about version 4 in your browser), 
• remove all dll from your project 
• remove component in palette to make sure you are not using old ones
• add it again (browse to the ajax dll) and add all object, it would happen you change version of your Ajax toolkit.
• in that version scriptmanager does not exist anymore, instead you have ToolKitScriptmanager, drag one and you won't get the error anymore. (make sure you only have one, clear all existing in master page or other)