/e is your friend but don't get too friendly:

#!/bin/perl -w  
use strict;

my $string="hello
<tag>
code
goes
here
</tag>
";

$string=~ s{(<tag>.*?</tag>)}{replace( $1)}egs;
print $string;

sub replace 
  { my $text_in_tag= shift;
    $text_in_tag=~ s{\n}{<br />}g;
    return $text_in_tag;
  }
[download]

The e modifier means that the replacement expression is eval-ed instead of being treated as a string. Hence $1 is replaced by replace( $1)

You can also use the old function-in-a-string trick: