Naval patrol craft engaged five boats of the Liberation Tigers of Tamil Eelam (LTTE) off the coastal district of Puttalam and one was sunk, a Sri Lankan military spokesman said.
"We believe one was carrying at least two suicide cadres and it exploded and sank when we opened fire at it," the spokesman said, adding the other four boats escaped.
A naval craft was damaged and a sailor was wounded during a firefight, the spokesman said.
However, the Tigers denied they lost any craft and said only three of their boats were involved in a 15-minute firefight.
"All three of our boats returned to base safely," LTTE spokesman Rasiah Ilanthiriyan said by telephone from his office in the rebel-held town of Kilinochchi.
"We have sunk one Sri Lankan navy inshore patrol craft," he said.
Tiger rebels had seen the navy taking away the bodies of seven sailors killed in the confrontation, he said.
The navy insisted only one of their sailors was injured and there were no fatalities.