The body of one of the slain soldiers was found badly mutilated in a forested area of the Himalayan territory, said Rajesh Kalia, spokesman for the Indian army's Northern Command.
A Pakistani army spokesman denied what he said were Indian allegations of unprovoked firing across the Line of Control (LoC) between the nuclear-armed neighbours.
He branded India's allegations as propaganda to divert attention away from a clash along the LoC two days earlier in which Pakistan said one of its soldiers was killed after an Indian incursion. India denied its troops crossed the line.
India and Pakistan have fought three wars since their independence in 1947, two of them over Kashmir.
Firing and small skirmishes between the two countries are common along the LoC despite slowly improving ties in recent years and deaths are now rarer. The Indian army says eight of its soldiers were killed in 2012, in 75 incidents.
Mr Kalia said yesterday's "intrusion" about 600 metres across the LoC in Mendhar – about 140 miles north of the Indian city of Jammu – marked "a significant escalation of ceasefire violations and infiltration attempts supported by the Pakistan army".
He added: "Pakistan troops, having taken advantage of thick fog and mist in the forested area, were moving towards their own posts when an alert area domination patrol spotted and engaged the intruders. The firefight continued for approximately half an hour, after which the intruders retreated back towards their side of the Line of Control."
He said India would take up the issue with Pakistan at a military flag meeting and also at a diplomatic level.
General S L Narasimhan told a television station: "What we have come to know is one body has been mutilated. That is what we are aware of."
In 1999, Pakistan-backed Islamist infiltrators occupied the Kargil heights in the north of Indian Kashmir. India lost hundreds of troops before re-occupying the mountains after bitter fighting that almost triggered a fourth war.
Indian military officials said the frequency of cross-border clashes has increased in recent weeks, with at least half a dozen ceasefire violations over the past week alone.
"I would say generally the picture has been a bit bleak," said Uday Bhaskar, an Indian military commentator and former director of the Institute for Defence Studies and Analyses, referring to relations between India and Pakistan.
"This incident only reiterates a certain pattern as far as the bilateral relationship is concerned."
He cited an apparent slowdown in Islamabad's commitment to granting India most-favoured-nation trading status and a recent visit to India by an adviser to Pakistan's prime minister whose comments infuriated the Indian government.
While the two nations remain rivals, relations between them have improved dramatically since the 2008 Mumbai siege in which 10 Pakistani gunmen killed 166 people and effectively shut down the city for days.
India claims the terrorists had ties to Pakistani intelligence officials – an accusation Islamabad denies.
Signs of their improving ties include new visa rules announced in December designed to make cross-border travel easier. Both countries have also been taking steps to improve cross-border trade. Pakistan's cricket team completed a two-week tour of India on Sunday, the first time it has visited in five years.