Paramilitary soldiers rescued about two dozen people from the blazing tax building after a two-hour gun battle in the heart of Srinagar, the summer capital of Jammu and Kashmir, as flames ripped through the floor above them.
Soldiers found the body of one separatist and search operations began for any more who threw grenades and fired automatic weapons before entering the building.
"Everybody was shouting and crying. Many people lay down to escape the bullets," said a dazed and teary-eyed Gulzareen, a government worker who was rescued from the building.
"We were terrified. We waved our scarves from the window so people could identify and rescue us."
Although India says separatist violence has declined in the revolt-torn region, about half a dozen people are killed daily in gun battles, bomb blasts and grenade attacks.
A 15-year rebellion against New Delhi's rule has claimed about 45,000 lives so far in Kashmir.
India accuses Pakistan of stoking the rebellion in Kashmir, a charge Islamabad denies.