In August 2006, Audi announced the arrival of the second generation S3. Offered in three- and five-door body styles, the second generation—Typ 8P—S3 is powered by a modified and uprated Volkswagen Group-sourced 2.0-litre turbocharged FSI petrol engine, with a maximum output of 195 kW (265 PS; 261 bhp). As with all Audi S models, the design was done in-house by quattro GmbH. The engine features uprated high-performance pistons, revised boost/fuel mapping, increased turbocharger size (KKK K04) and larger intercooler. The most powerful form of this widely used engine, and quattro four-wheel drive, makes for a 0–100 km/h (0–62 mph) time of 5.5 s, and an electronically limited top speed of 250 km/h (155 mph). Audi offers both six-speed manual and six-speed S-Tronicautomatic transmissions with the S3.

The chassis has had the spring rating and dampers revised, along with the body kit. Like its predecessor, although badged a "quattro" model, the S3 does not employ a Torsen centre differential (as in other common quattro models), but instead uses the Swedish Haldex Traction system in its on-demand four-wheel drive transmission, due to the transverse engine layout.