here is the explaination from
http://www.infotechguyz.com/server2008/domainfunctionallevel.html
<a href=http://www.infotechguyz.com/server2008/domainfunctionallevel.html>http://www.infotechguyz.com/server2008/domainfunctionallevel.html</a>
Windows Server 2003 domain functional level features
- Domain rename capability
Windows Server 2003 functional level supports rename of Active Directory domain.
- Cross-forest transitive trusts
Windows Server 2003 functional level supports transitive trusts between two or more Active Directory forests.
- Universal group caching
Windows Server 2003 functional level supports Universal group caching which eliminate the need for local global catalog server
- Intersite topology generator (ISTG) improvements
More efficient ISTG algorithm allows support for extremely large numbers of sites.
- Multivalued attribute replication improvements
This allows incremental membership changes.
- Lingering objects (zombies) detection
Windows Server 2003 ability to detect zombies, or lingering objects.
- AD-integrated DNS zones in application partitions
This allows storing of DNS data in AD application partition for more efficient replication.