Here is my suggestion using XSLT 2.0 and for-each-group
group-starting-with
in a recursive function:
<xsl:stylesheet
version="2.0"
xmlns:xsl="http://www.w3.org/1999/XSL/Transform"
xmlns:xs="http://www.w3.org/2001/XMLSchema"
xmlns:mf="http://example.com/mf"
exclude-result-prefixes="xs mf">
<xsl:output indent="yes"/>
<xsl:function name="mf:get-id-sub" as="xs:string">
<xsl:param name="level" as="xs:integer"/>
<xsl:sequence select="string-join(for $i in 3 to $level return 'sub-', '')"/>
</xsl:function>
<xsl:function name="mf:group" as="element()*">
<xsl:param name="elements" as="element()*"/>
<xsl:param name="level" as="xs:integer"/>
<xsl:for-each-group select="$elements" group-starting-with="*[local-name() eq concat('h', $level)]">
<xsl:choose>
<xsl:when test="not(self::*[local-name() eq concat('h', $level)])">
<body>
<xsl:apply-templates select="current-group()"/>
</body>
</xsl:when>
<xsl:otherwise>
<topic id="{mf:get-id-sub($level)}headingtitle">
<xsl:apply-templates select="."/>
<xsl:sequence select="mf:group(current-group() except ., $level + 1)"/>
</topic>
</xsl:otherwise>
</xsl:choose>
</xsl:for-each-group>
</xsl:function>
<xsl:template match="@* | node()">
<xsl:copy>
<xsl:apply-templates select="@* , node()"/>
</xsl:copy>
</xsl:template>
<xsl:template match="topic[@id = 'pageTitle']/body">
<xsl:sequence select="mf:group(*, 2)"/>
</xsl:template>
<xsl:template match="h2 | h3 | h4 | h5 | h6">
<title>
<xsl:apply-templates/>
</title>
</xsl:template>
</xsl:stylesheet>
It transforms
<topic id="pageTitle">
<title>Page Title</title>
<body>
<h2>heading title</h2>
<p>some more content under h heading</p>
</body>
</topic>
into
<topic id="pageTitle">
<title>Page Title</title>
<topic id="headingtitle">
<title>heading title</title>
<body>
<p>some more content under h heading</p>
</body>
</topic>
</topic>
and
<topic id="pageTitle">
<title>Page Title</title>
<body>
<p>some contents.</p>
<h2>heading title</h2>
<p>some more content under h heading</p>
<h3>sub-heading title</h3>
<p>some more content under sub heading</p>
<p>some more content under sub heading</p>
<h2>heading title</h2>
<p>some more content under h heading</p>
</body>
</topic>
into
<topic id="pageTitle">
<title>Page Title</title>
<body>
<p>some contents.</p>
</body>
<topic id="headingtitle">
<title>heading title</title>
<body>
<p>some more content under h heading</p>
</body>
<topic id="sub-headingtitle">
<title>sub-heading title</title>
<body>
<p>some more content under sub heading</p>
<p>some more content under sub heading</p>
</body>
</topic>
</topic>
<topic id="headingtitle">
<title>heading title</title>
<body>
<p>some more content under h heading</p>
</body>
</topic>
</topic>