"My players have got big heart and great desire to do well. That won us the match," said Japan coach Kyoichi Nagaya.
"We are grateful to be given the chance to be here. We learnt a lot and will take the experience to the Junior World Cup."
England took the lead through Jack Clee with a reverse shot in the 20th minute but the Japanese cancelled the lead from Miyu Tanimitsu's penalty corner in the 31st minute.
Jon Bleby's men ensured they still went into the break with a lead after Jack Waller scored from open play just seconds before the half-time hooter.
Japan, who have refused to accept defeat in just about every match they've play at Taman Daya Stadium thus far, again showed their resilience and determination to turn the tie around in the second half.
They were rewarded with a goal by Kaito Tanaka after he skipped past two defenders before unleashing a shot into the top corner.
Japan converted all their attempts in the shootout with Koji Yamasaki, Kaito Tanaka, Shinichi Kamezaki and Ryo Ozawa beating Toby Reynolds-Cotterhill while only Peter Scott scored for England.
Japan goalkeeper Keita Matsuda saved attempts Jack Clee, Rhys Smith.
"I'm upset that we lost. We played some brilliant hockey but did not have execution. We need to the ball across the line," said Bleby.