The offices of the privately-owned English-language Red Pepper, and its vernacular sister publications, were raided and eight employees arrested, police said.
The story in question, published on Monday, said President Yoweri Museveni was plotting to overthrow his Rwandan counterpart, Paul Kagame.
Besides being false the story was a threat to regional security, police spokesman Emillian Kayima said.
"The Uganda police force initiated investigations into the serious statements and insinuations in that story, that have grave implications on national and regional security and stability," Kayima added.
The newspaper's lawyer Dickens Byamukama said the eight directors and editors are being detained at Nalufenya prison outside the capital Kampala.
"Their phones, laptops were confiscated, plus other official and private equipment," Byamukama said, adding that the Red Pepper's premises have been cordoned off. The newspaper did not appear on newsstands today.
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