Unfortunately, this can only be fixed at the end of Outlook by setting the "Allow UTF-8 support for the mailto: protocol. (In 2010, this is located under Options → Advanced → International Settings.)
Otherwise, and by default, Outlook will use the default default encoding for the local user (ANSI code page), which is never UTF-8. This makes the use of non-ASCII characters in mailto: URLs so unreliable as to be useless. (Even more than the normal insecurity of subject= .)
In general, the idea of URL coding a non-ASCII string was correct: using a URI, for example:
<a href="mailto: test@gmail.com ?subject=%E0%A4%AE%E0%A4%BE%E0%A4%A8%E0%A4%95%20%E0%A4%B9%E0%A4%BF%E0%A4%A8%E0%A5%8D%E0%A4%A6%E0%A5%80">Testing</a>
More reliable than IRI format with raw Unicode. However, this does not apply to the Outlook problem.
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