The battle was triggered after eight police officers were killed in an ambush on a main road west of Kandahar city on Wednesday.
Yousuf Stanizai, a spokesman for the interior ministry, said 12 Taliban members had been killed and that the fighting was ongoing.
However, Mawlavi Samad, a local Taliban commander, said only one Taliban fighter had died while 15 policemen had been killed. There was no independent verification for either side's claims.
Despite a heavy foreign military presence since 2001 when US-led forces overthrew the Taliban government, recent bloodshed around the country has been the worst since the war.
Fighting in the south increased towards the end of July as Nato was building up its presence before taking over the region from US forces.
Nato's expansion into the south is the biggest ground operation in the alliance's history.
It is expected to move into the east later this year.