EDIT: Hey, IDNs seem to work! http://café.jpg.to/
EDIT 2: Or maybe not. http://schlüssel.jpg.to/
(Schlüssel means "key" in German. Google Image Search it and you get pictures of keys. Search for "Schlussel", though, and you get that girl. So presumably it searched for the punycode, something like --schlussel-blah.)
EDIT 3: Wait. the IDN for "Schlüssel" is xn--schlssel-95a. If I Google that, I don't get pictures of Ms. Schlussel. It must be decoding it and stripping the accents? That said, searching for schlssel does yield pictures of her.
EDIT 4: café is --xn-caf-dma. Google Image Search "caf" won't find cafés. Nor will "--xn-caf-dma". So it must understand IDNs but strip or be accent-insensitive