Hi Guys,
I have been able to resolve this issue in two steps.
1. The settings I changed (use ASP.NET4.0 instead of 2.0) on the virtual directory for the test apps was fine but i had neglected to do the dame on the actual default website folder as well. This immediately cleared the <compilation debug="true" targetFramework="4.0"/> part of the problem.
2. I then found that after installing .Net framework 4.0 the Web Service Extensions of for ASP.NET 4.0 is set to prohibited by default in IIS. I therefore enabled this.
Both the older .NET 3.5 apps and new .NET 4.0 apps work fine alongside each other on the same server.
PS: There were numerous solutions relating to errors on line <compilation debug="true" targetFramework="4.0"/> . Those did not work for me and the above did. Conversely, this may not work for you and google may dig up something that does for you.
Thanks
J