The 20m (66ft) Dignity was carrying 15 civilian passengers, including several doctors, journalists, a former US congresswoman and a member of the Cypriot parliament, says Free Gaza.
The organisation sent out an urgent statement on Tuesday saying the vessel had been surrounded by at least six Israeli military ships.
"They are firing live ammunition around the Dignity, and one of the warships has rammed the civilian craft causing an unknown amount of damage," said the statement.
"We heard heavy gunfire in the background before all contact was lost with the Dignity."
The Dignity's captain, Denis Healey, told reporters in Tyre they had been attacked "without any warning, any provocation, or anything".
Free Gaza said the incident was "an act of terrorism", as well as a violation of international maritime law and the UN Convention on the Law of the Sea.
Crowds turned out to greet the Dignity as it arrived in Tyre port.
