You can't use HDMI-ARC to get audio from the TV to the HTS because the HTS doesn't support that.
You will need to connect the headphone output to the line level stereo input on the HTS. Select Dolby ProLogic as your surround mode since you can only get stereo into that HTS.
If you turn the TV volume up to high it will distort regardless of the volume of the HTS so don't use the TV remote to control the volume use the HTS remote.