Sources warned Sunak of the dangers of tarnishing Zahawi’s reputation in October, Nadim Al-Zahawi

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Rishi Sunak was told there could be a reputational risk to the government from Nazim Zahawi’s tax affairs when he appointed him chairman of the Conservative Party in October, sources tell The Observer.

The sources said that during the period when the prime minister was forming his new government, senior government officials gave him informal advice on the risks involved in the HRM investigation that was settled only months earlier.

This included warning Sunak, whose knowledge of Zahawi’s financial affairs at the time of his appointment had come under close scrutiny in recent days, that the tax matter involved a large amount of money and was not, as alleged, a trivial accounting error.

Downing Street strongly denied that Sunak, whose judgment on Zahawi’s reappointment had come into question, had been given an informal warning about Zahawi’s finances. There is no indication that Sunak received an official warning. A spokesperson for No 10 said: “These allegations are not true. These details have not been communicated to the Prime Minister, informally or otherwise.”

Al-Zahawi issued a statement last Saturday after the Guardian revealed he had paid a fine to HMRC as part of a £5m settlement.

He said, “They concluded that this was a ‘negligent and unintentional’ mistake. So that I could focus on my life as a public servant, I chose to settle and pay what they said was due, which was the right thing to do.” The spokesman declined to make further comments on the latest revelations.

At the time of the cabinet reshuffle, Zahawi’s name was particularly associated with the role of Minister of Education, a position he had previously held, as some Conservative Party insiders had speculated that he might return to the department, but he ended up in a less central position.

The Conservative Party boss is battling to save his political life after finally admitting to settling with the tax office after a mistake over a multimillion-pound contribution to polling firm YouGov.

Sunak, who has asked his ethics advisor to investigate the matter, told MPs on Wednesday that “the usual process of appointments was followed” and “no issues were raised with me when [Zahawi] appointed to his current position.”

Days before The Guardian revealed and Zahawi’s public statement admitting the mistake, Sunak said he had “addressed this fully”.

Government sources familiar with the discussions about the cabinet appointments confirmed on October 25 that no formal “flag” or warning about Zahawi’s tax affairs was raised with the prime minister when he appointed him. They also confirmed to follow the usual process.

However, various sources alleged that additional informal advice was given to Sunak in the days following the appointment of Cabinet Secretary Simon Case and senior officials, warning him of the risks of discrediting the government as a result of Zahawi’s finances and the HRC dispute.

This included some details about Zahawi’s dispute with HMRC that became available to the Cabinet Office and Downing Street through unofficial channels, according to sources. HMRC does not share detailed information about individuals’ taxes through the official appointment process for privacy reasons.

The same sources said that while the prime minister did not receive a full breakdown or direct evidence of the settlement Zahawi made with the tax office, he was told that in such circumstances a fine might be due.

He was further informed that the tax issue involved a large amount and that it was not a trivial accounting error. Sunak has also been told that the HMRC issue has been resolved, sources claim, and the official Cabinet Office flag has been brought down against Zahawi’s name.

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The dispute with HMRC is set over concerns at the top of the government about Zahawi’s complex financial arrangements, according to insiders.

The new allegations come after the Guardian newspaper reported that Sunak was briefed on an investigation into a minister’s tax affairs while he was chancellor in the summer of last year.

The matter was raised with him after Whitehall officials escalated in response to a freedom of information request. Downing Street denied being told at the time that Zahawi was the minister under investigation.

Sunak asked his new ethics adviser, Sir Laurie Magnus, to investigate Zahawi’s tax affairs after acknowledging there were “questions that need answering”.

Al-Zahawi offered to share his tax information with the investigating committee after the head of the human resources department, Jim Harrah, increased pressure on him by telling MPs that “there are no penalties for innocent mistakes.”

But the investigation gave the prime minister, who has reiterated his promise to run a government of “integrity and accountability,” time to fend off calls for Zahawi’s dismissal.

During the investigation, Zahawi will remain party chairman, a job that over the next few months will include orchestrating Conservative party strategy in the run-up to local elections this spring.

Sunak is under pressure on a number of fronts, amid an investigation into mounting complaints of bullying against the deputy prime minister, Dominic Raab, and a growing legal defense bill for Boris Johnson in the Privileges Partigate inquiry.

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