At lunch, Australia were 42 for one in reply to England's first innings 361, a deficit of 319 runs.
Watson, who has scored just two hundreds in 42 previous Tests, looked in good touch making 30. But with just two balls of the session left he played across the line of a Tim Bresnan delivery and was given out lbw by Sri Lankan umpire Kumar Dharmasena.
Even though wasted reviews had cost Australia dear during Ashes-holders England's 14-run first Test win at Trent Bridge last week, Watson sought a referral.
Earlier England's Stuart Broad and Graeme Swann frustrated Australia by adding 48 runs for the last wicket.
Ryan Harris led Australia's attack in fine style with five wickets for 72 runs in 26 overs.
England resumed on 289 for seven after Ian Bell's 109 rescued them from the depths of 28 for three.
Harris, recalled in place of the dropped Mitchell Starc for his first Test in over a year, had a wicket with today's first ball when Bresnan was caught by diving wicketkeeper Brad Haddin.
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