If you were considerina a B7 A4 vs A3, A4's lose. I own a B7 A4 and a GTI (Basically the same as the A3). I can tell you that the rear space is about the same in these cars in rear seating but you can cram more into the Hatchback. DSG is awesome as well as the car being much lighter. The Hatch will be way quicker. The B7's use the same engine so there is no difference in power there. The 2.0t will not offer you AWD with the A3 though. Only the 6cyl. model has AWD.

The wife thought the A3 looked odd at the time of our A4 purchase but now we make every family trip in my GTI for space reasons. Sedans and Truncks suck!

 

This is a pretty good comparison breakdown. My first car ever was an 97' A3, followed by a 2002 A4 and now, I'm in an '07 A3. The A4 had a 5 speed standard transmission while my A3 is a 6 speed. I can honestly say that I enjoy the A3 much better than A4. For me, the A3 is more fun drive than the A4 and handles a lot better.

 

The A4 has a better AWD system. I myself have an A3 but because I wanted the 3.2 for a reasonable price. If you want the 3.2 in the A4 it's some serious scratch.

 

Oh yeah, I used to have an A4 (2005.5 2.0T) It was nice, I liked the AWD better in the A4, but I love the functionality of the hatch (I will never buy another non-wagon/hatch again) and the zip of the 3.2, it's pretty sweet having a 6 cylinder in a small hatch.

 

I have driven a couple of A3's here in Germany (loaners from dealer) and I have got to say they are nice. These two I drove did not have all the features of my A4 but they were compact (3 door versions not Sport Back) and very fun to drive. Both were TDI's, one was the older 1.9TDI 105hp and the latest one was a 2.0TDI 140hp. Have to say the 140hp with 320nm torque can really do the 60-120kmh pretty damn good! I am looking at used German spec'd versions of the A3 (3 door) for my wife. She is thinking of selling her 2003 MB A160 and getting a TDI due to its low fuel usage and great torque.

 

All good cars to be looking at. From my experiences, the A4 will definitely give you a more refined or quiet ride (as mentioned before), and you will have a more confident feeling AWD in slippery weather. Im sure under normal driving conditions you wouldn't notice any difference between the Haldex and Torsen systems.

The A3 is a really neat, practical, and peppy hatch and I really like them. And to correct a previous statement, the A3's are available in 2.0t awd. I sat in and test drove a used one at a dealer recently- very nice cars indeed.

The other consideration for the mazda3 or mazdaspeed3, is very thoughtful and economical. My girlfriend has a sport hatchback, and its a BLAST to drive (coming from an A4 owner). Its quick (the 2.3 was ~160hp if i recall, not sure about the new 2.5's), very light and nimble, and very well equipped (with 6disc cd changer, premium sound, sunroof) for the price. If the leather and heated seats are a big concern, then there is the grand touring package which offers those plus navigation, and some nice bi-xenons. Mileage is also very good in these cars, and build quality is top notch.

Hope this can help the thought process. Best of luck!