"We were alerted to the abandoned taxi by another man who escaped from the Tigers yesterday," the official said. "We were suspicious of the vehicle and as we got near, the vehicle exploded."
The dead man placed in the three-wheel taxi had been abducted on Thursday, police said.
Officials blamed the rebel Liberation Tigers of Tamil Eelam (LTTE) for the attack.
There was no comment from the Tigers.
The blast came a day after thousands of Muslims in the neighbouring district of Trincomalee began returning home a month after fighting caused them to flee.
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Sri Lanka has suffered an upsurge in bloodshed since December that has left more than 1,500 people dead by official count. The island's three-decade-old separatist ethnic conflict has claimed more than 60,000 lives.