The two companies, which unveiled their smart car tie-up in November, have been working together informally on chips for the last few months, two of the sources said. A third source said they might soon form a joint venture for chip development.
Shares in Changan rocketed higher on the news, closing up 8.5% compared to a 4% decline earlier in the day.
Huawei has pivoted to electric vehicles after its global smartphone business was hammered by U.S. sanctions. The previous Trump administration labelled the company a threat to U.S. national security - a charge it denies.
In addition to the deal with Changan to develop smart cars under a joint as-yet-unnamed brand, Huawei is also planning EVs under its own marque and is in talks to take control of a small domestic automaker's EV unit, sources have said.
Huawei's new chip partnership with Changan would come amidst a global semiconductor shortage that has hit automakers particularly hard.
It would also represent a significant expansion for Huawei's chip business after U.S. sanctions meant it lost access to the underlying chip design software needed for more advanced chips used in smartphones.
The sources declined to be identified as they were not authorised to speak to media.
Changan did not respond to a request to comment. Huawei said it defers to automakers in public announcements regarding their tie-ups. Battery maker CATL, which is also part of the smart car partnership, also did not respond to a request for comment.
Changan, which has partnerships with Ford Motor Co and Mazda Motor in addition to making its own cars, has been working on developing its own chips but has not made much progress, two sources said.
Huawei and Changan's smart car partnership calls for the tech giant to be in charge of the vehicle's operating system and cabin technologies while the automaker would be in charge of vehicle design and engineering.
Two sources said the partnership would build cars that would target the mid to high-end market, competing with Tesla Inc and Nio Inc.
The business will be housed in an old venture with Nio that is no longer active and has been renamed Avatar, they added.
The companies aim to begin sales early next year, said one source. Another source added that Avatar will open an office in Shanghai and has started hiring staff.
Avatar might go public, Changan said on Friday on a question and answer service for investors managed by the Shenzhen stock exchange.
Earlier this week, sources told Reuters that Changan plans to list its EV unit, which is separate from Avatar, on Shanghai's Nasdaq-style STAR Market. Changan did not respond to a request for comment.
(Reporting by Yilei Sun in Beijing and Julie Zhu in Hong Kong; Additional reporting by David Kirton in Shenzhen; Editing by Edwina Gibbs)
By Yilei Sun and Julie Zhu