Here's an update on the story:
The heads went off to the machine shop and came back 3 weeks later looking all shiny with all the valves properly seated and the valve clearances set.
The shop wanted me to provide the new valve stem seals. Don't buy the Jaguar ones. The Lincoln 3.9L engine has exactly the same seals for about one quarter the price.
OK, so $800 later I have two new heads. I cleaned off the block and gave them a quick 400grit flat block sanding. With the help of a buddy (these things are heavy when you have the exhaust manifold attached) I placed them in position and torqued them down with new head bolts.
I then re-assembled everything, including the horrible-to-get-at power steering pump and A/C compressor. I used the "old belt tightened around the crankshaft pulley" trick to hold the pulley in place while torquing it tight.) The engine started right up but was rough at idle, smooth at higher revs.
No misfire codes anymore but I did have two codes for incorrect timing P0016 and P0018. I was really bummed. When setting the timing, I had the camshafts locked down correctly with the special tool. All I can think of was that the engine wasn't perfectly at TDC. The problem is that there's no marks to tell you. At least none that I can see on my engine. When you slot the crankshaft locking tool in, there's 3 slots it could possibly go in. None of them marked. How stupid is that! The crank can be rotated a few degrees either way without the piston at #1 noticeably moving. Now, Audi engineers are remarkable stupid about a lot of maintenance things but at least TDC is marked clearly.
There was nothing for it but to drain the coolant and the P/S fluid and strip down again. Fortunately I hadn't charged the A/C.
(I found that removing the P/S pulley first is a much better solution in getting access to the pump connections and bolts.) I almost have the front covers back off.
That's as far as I've got. So if anyone has some tips on getting the timing right I'm all ears. I guess I have to order some new one-time use bolts again!
Mark

 

the engine is not timed at TDC

 

That is vague...
Are you saying GBMarc's engine is not timed at TDC, or that the engine in general is not timed while at TDC? One bank? Both banks?
Please be more specific when you post, it'll help over-evaluators like me.

 

tool is inserted 45 after tdc. rotate all cams till flats point up

 

I have the X150 4.2 service manual. On page 947 it says to rotate the #1 cylinder to TDC and then insert the locking tool. It then describes removing the chains, tensioners and camshaft sprockets. On re-assembly the camshaft flats are locked in the facing-up position. Then the camshafts sprockets are tightened, (intake first) while force is applied to tension the drive side of the chain using the special tool.
There is no further mention of changing the crankshaft position to 45 degrees. If I'm following instructions I would assume it's still at TDC on piston #1.
Where does this 45 degree instruction come from?

 

from the engine repair course

http://jagrepair.com/images/Training%20Guides/168_sg.pdf

there’s only one oval shape hole in the flex plate where the locking tool is supposed to go

 

This engine repair course is for the earlier engines but I'm assuming it applies to a 4.2 2008 engine?
Thanks xalty! This would explain a lot. I just went and checked out underneath the car. There is indeed an oval shaped hole in the flex plate which lines up with the sensor gap when the crankshaft is positioned around 45 degrees ATDC. In fact I should have realized because I left a blue marker stroke on the crankshaft at 12 o'clock the last time I dismantled to mark the position of the crankshaft when the camshaft flats were locked in with the camshaft locking tool.
So . . . this omission in the Service Manual that I have, just cost me a lot of pain and aggravation.
I'm gonna tighten up the camshaft bolts in this new position and button everything back up once my new crankshaft pulley bolt arrives.

 

WOW thats terrible! The repair manual is a good guide but this wouldn't be the first time I've seen an error.

After this thread, I won't feel bad about second guessing everything in there.

 

The error in the manual comes down to a single "Caution" sentence in the "Timing Drive Components" section on page 947. It says
"Caution: Rotate the crankshaft clockwise to position the engine to top dead center (TDC) number 1 cylinder."
And then
Lock the crankshaft using the special tool 303-645.
These are incompatible statements because if you try it, the special tool won't fit it the flex plate. Also, if you're dismantling, the camshafts will then not be where you can attach the camshaft locking tool.
I searched the whole pdf manual for "45" and not once does it mention 45 ATDC.
There's a later section in the manual where it repeats the whole timing chain installation procedure in the context of installing cylinder heads (around p1451) and in that section it doesn't make the same mistake of mentioning TDC. It simply starts with you locking the crankshaft with the lock tool.

 

I'd think that would be a rather important item to change in a workshop manual in all these following years.

 

As a wrap up to this story:
The car was re-timed at 45 ATDC and ran perfectly when I re-started it. Well, it did squeal, but that was the accessory belt on the bent power steering pulley. The pump had fallen accidentally off my bench and bent the pulley. I tried straightening it but it didn't work. I had to put on a used pump and pulley and new belt before the squeal was fixed.
All my engine codes were cleared up with this head rebuild and new head gasket.
It was a ton of work but the engine feels good and crisp now with all 8 cylinders. I paid $800 to get both heads checked, cleaned and all valves seated and adjusted correctly. There was probably another $400 or so in other gaskets and fluids etc.