Video footage taken by a bystander shows 27-year-old Mido Macia tussling with half a dozen uniformed and police officers some clad in stab vests and at least one brandishing a pistol.
It then shows Macia being handcuffed to the back of a police van and dragged to the local police station, in front of a large crowd of shocked bystanders.
"Hey! Hey! Why are you hitting him?" one person in the crowd can be heard shouting in Zulu.
Macia was later taken into custody, where he was found dead less than two hours and 25 minutes later, according to investigators.
The cause of death was found to be head injuries with internal bleeding, investigators said.
The Independent Police Investigative Directorate has now opened a murder investigation.
"We are investigating an incident involving the death of man, allegedly at the hands of the police. We are shocked by the footage which has been released," said Independent Police Investigative Directorate spokesman Moses Dlamini.
"The circumstances surrounding his death are still allegations... let's find out what really happened," he said.
The police watchdog and witnesses said two officers a warrant officer and a constable had initially confronted Macia at around 18:50 (1650 GMT) for parking his Toyota Avanza taxi illegally.
Eyewitnesses said Macia had been trying to get his driving license back from the police when an altercation occurred. The witnesses denied police suggestions that he had tried to disarm one of the officers.
"He was just pushing them, not trying to take the gun," said George Nxumalo, a 57-year-old Daveyton resident.
The taxi driver was found dead in his cell at around 21:15 (1915 GMT). The incident has caused outrage across South Africa.
Daveyton residents marched on the police station on Wednesday, but claimed they were dispersed with pepper spray.
"They are criminals in uniform, we don't want them, we want the law to take its course, otherwise we will take the law into our own hands," said Bongani Hlela, a street trader based nearby.
"Just because he was Mozambican does not mean that he should be treated badly. We are all African, we have rights," he added.
Police commissioner Riah Phiyega expressed "deep concern" about the incident.
"The matter is viewed by the National Commissioner in a very serious light and it is strongly condemned," a statement said.
It is just the latest in a series of crises to hit the beleaguered police service, which was pilloried for the shooting dead of 34 miners on one August day and for its handling of the Oscar Pistorius case.
"This appalling incident involving excessive force is the latest in an increasingly disturbing pattern of brutal police conduct," said Noel Kututwa, Amnesty International's southern Africa director.
The Independent Police Investigative Directorate received 720 new cases for investigation of suspicious deaths in custody or in other policing contexts from April 2011 to March 2012, according to Amnesty.
In 1998, film emerged of four officers setting their dogs on three Mozambicans which sparked a massive outcry.
The opposition Democratic Alliance party called for a full investigation by South Africa's human rights commission and for the officers involved to be suspended.
"Macia paid for parking on the wrong side of the road with his life. Instead of issuing him with a ticket, the police killed him," said shadow police minister Dianne Kohler Barnard.
"How much longer must South Africans live in fear of the very people who are supposed to protect them?"
The police department said the officers had not yet been suspended.
The Mozambican Embassy in Pretoria said it had dispatched an official to the area to find out more.