The Hedgehog signalling pathway is deployed repeatedly during normal animal development and its inappropriate activity is associated with various tumours in human. The serpentine protein Smoothened (Smo) is essential for cells to respond to the Hedeghog (Hh) signal; oncogenic forms of Smo have been isolated from human basal cell carcinomas. Despite similarities with ligand binding G-protein coupled receptors, the molecular basis of Smo activity and its regulation remains unclear. In non-responding cells, Smo is suppressed by the activity of another multipass membrane spanning protein Ptc, which acts as the Hh receptor. In Drosophila, binding of Hh to Ptc has been shown to cause an accumulation of phosphorylated Smo protein and a concomitant stabilisation of the activated form of the Ci transcription factor. Here, we identify domains essential for Smo activity and investigate the sub-cellular distribution of the wild type protein in vivo. We find that deletion of the amino terminus and the juxtamembrane region of the carboxy terminus of the protein result in the loss of normal Smo activity. Using Green Fluorescent Protein (GFP) and horseradish peroxidase fusion proteins we show that Smo accumulates in the plasma membrane of cells in which Ptc activity is abrogated by Hh but is targeted to the degradative pathway in cells where Ptc is active. We further demonstrate that Smo accumulation is likely to be a cause, rather than a consequence, of Hh signal transduction.