Reactive power compensation plays a key role in reducing distribution losses by improving power factor. A three phase three wire DSTATCOM consisting of a five level H-bridge Voltage Source Converter (VSC) is proposed for improving power factor in the distribution system at the Point of Common Coupling (PCC) when the load is continuously changing. The sliding mode control algorithm is used for reactive power compensation and achieve unity power factor. To accomplish this DSTATCOM is controlled to supply or absorb reactive power at PCC. Sinusoidal PWM method is used for obtaining the switching pulses for the cascaded H-bridge converter. The performance of the DSTATCOM controlled distribution system is validated by simulations using MATLAB/Simulink software and Power System block set toolboxes.