The conflict has killed more than 5,000 people in the past 18 months.
The rebel Liberation Tigers of Tamil Eelam (LTTE) shelled the Pampaimadu military position where security forces had placed a long-range gun, the sources said.
Heavy shelling was heard on Saturday night in Pampaimadu in the district of Vavuniya, which borders the rebel-held Wanni region, residents and officials said.
The defence ministry said that the LTTE attack had been repulsed using mortars and artillery and a search operation was underway in the area on Sunday.
"The army retaliated with mortar and artillery fire targeting LTTE artillery and mortar positions and reports confirm that heavy casualties were sustained by the LTTE," the defence ministry said in a statement.
It placed military casualties at one soldier killed and seven wounded. However, official sources said they feared military losses were higher and that at least 15 soldiers had been taken to hospital.
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