Hedgehog (Hh) signalling is crucial for developmental patterning and tissue homeostasis. In Drosophila, Hh signalling is mediated by a bifunctional transcriptional mediator, called Cubitus interruptus (Ci). Protein Kinase A (PKA)-dependent phosphorylation of the serpentine protein Smoothened (Smo) leads to Ci activation, whereas PKA-dependent phosphorylation of Ci leads to the formation of Ci repressor form. The mechanism that switches PKA from an activator to a repressor is not known. Here we show that Hh signalling activation causes PKA to switch its substrates from Ci to Smo within the Hh signalling complex (HSC). In particular, Hh signalling increases the level of Smo, which then outcompetes Ci for association with PKA and causes a switch in PKA substrate recognition. We propose a new model in which the PKA is constitutively present and active within the HSC, and in which the relative levels of Ci and Smo within the HSC determine differential activation and cellular response to Hh signalling.