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After 120 minutes of goalless action, both sides converted most of their kicks, but Kerala's substitute Sujith V R missed the decisive one.
Kerala will meet the second-placed team from Group B in the fourth quarterfinal on Tuesday (7 pm).
Services outplayed Assam 2-0 in the early kick-off to seal their place in the quarterfinals.
Kerala, who beat Assam 3-1 in their opening match before going down 0-2 to Goa, have four points from three games.
Satheevan Balan's Kerala suffered their first loss with Goa winning 2-0.
Services defeated Meghalaya 1-0 in the inaugural match of the final round.
SAT Tirur crushed KSEB 5-2 to join Kerala Police, Muthoot FA and Kerala United in the semifinals.
Earlier, the Argentine national side had offered to visit Kerala in June in response to an invitation extended by the state government.
The tournament will be held in Arunachal Pradesh from February 21 to March 9.
Vice-captain Avinash starred with a brace, while captain Mohammed Irshad and Gadson Cherian scored one apiece in the final.