As far as I can tell, the links in the database are not updated, the images are not downloaded to be stored on the new server, and the images remain on WordPress.com.
Did you try turning on the "Import Attachments" checkbox?
Seriously, I know this works. I've done it myself. It does exactly what you say that it does not do. There's whole functions in the import/wordpress.php file designed specifically to do just what you're talking about. The backfill_attachment_urls() function changes URLs of attached files in posts to their new values when they get imported. The process_attachment() function actually retrieves the remote attachment from the old server.
Now, this may be new to 2.5 (pretty sure it is, in fact), but it's there and it does indeed work.