DC capacitors in sub-modules are one of the main influence factors of MMC-UPQC’s cost and volume. Too large capacitance of DC capacitors will affect the practicability of MMC-UPQC in distribution network application. A control strategy is proposed to reduce the capacitance of DC capacitors in MMC-UPQC, in which shunt converter of MMC-UPQC absorbs appropriate quantity active power during voltage sag. Capacitance calculation methods of DC capacitors in MMC-UPQC with different voltage sag compensation strategies are analyzed, which points out that the proposed voltage sag compensation strategy has advantage on reducing the capacitance of the DC capacitors in MMC-UPQC. Through the simulation in PSCAD, the correction of the proposed voltage sag compensation strategy is verified. Using the proposed voltage sag compensation strategy in MMC-UPQC can reduce DC capacitors’ capacitance, save the equipment cost and reduce the equipment volume, which improve the practicability of MMC-UPQC in distribution network application.