The BBC's Sushil Sharma in Kathmandu says it is the worst attack since the Maoist insurgency was launched more than four years ago. The attack comes a week after the government announced that it was intensifying police action against the rebels. Police said a few hundred rebels attacked and completely destroyed the police station in Dunai. They said the rebels had also suffered casualties but did not say how many. The injured policemen have been moved to hospitals in the capital, Kathmandu, by helicopter.
Reports say the rebels looted tens of thousands of dollars in cash and jewellery from a local bank.
Our correspondent says the Nepalese Government is concerned about the latest violence and have ordered strict security measures throughout the country. The rebels want to set up a communist republic in the Nepal - the world's only Hindu kingdom. Amnesty International and the United Nations have criticised both the government and the rebels for human rights abuses in the conflict. Both sides are under international pressure to start a formal process of peace talks.