The school, which educates about 2500 Muslim students in Sydney's south-west, is refusing to pay back the financial assistance it received between 2010 and 2011, three years after the NSW Minister for Education, Adrian Piccoli, declared that it had been unlawfully operating for profit.

In court documents, Malek Fahd said legislation introduced into NSW in October 2014 is contrary to the federal Racial Discrimination Act.

The legislation allowed the minister for education to declare that any financial assistance provided could be recovered as a debt if a school had operated for profit.

Last month, the school launched a cross-claim, arguing the minister doesn't have the power to declare that it was operating for profit and recoup the funding. It has further argued that the NSW government still owes it state funding for the period from July 2012 to December 2013, approximately $1.2 million based on previous MySchool data.

The NSW government has asked the Supreme Court to force Malek Fahd to repay the $8.5 million it owes plus legal costs and interest at nine per cent.

Despite the litigation, the school is pushing ahead with rapid expansion plans for its third campus in Hoxton Park, on top of its multi-million dollar operations at Greenacre and Beaumont Hills.

The Greenacre campus received $17.5 million in federal government funding in 2013, making up 75 per cent of its total income.

An average private school would receive one-quarter of that percentage in public funding.

The litigation comes as the school continues to be investigated by the federal Department of Education.

In June the federal department launched an investigation after a string of sackings among senior staff members and principals, allegations of financial mismanagement and concerns over the delivery of the curriculum at a number of Australian Federation of Islamic Councils (AFIC) schools.

A spokesman for the Department of Education said that there are specific concerns with some financial arrangements between the schools and AFIC.

Five other schools associated with AFIC will come under the audit including the Islamic College of Brisbane, the Islamic College of Melbourne, the Islamic College of South Australia, the Islamic School of Canberra and Langford Islamic College in Western Australia.

In court documents, Malek Fahd said the agreement between AFIC and the school was "irrelevant" and that the Minister no longer had the power to order AFIC to remain at arm's length from the school board.

The Minister for Education, the Department of Education and Malek Fahd all declined to comment due to ongoing litigation.