Here is the solution. (Thanks to Ricardo over at DynamicReports help forum!)
The image servlet must indeed be registered in /src/templates/war/web.xml configuration. We did not have to do this in Grails 1.3.7. Hope this helps someone else!
<servlet>
<servlet-name>ImageServlet</servlet-name>
<servlet-class>net.sf.jasperreports.j2ee.servlets.ImageServlet</servlet-class>
</servlet>
<servlet-mapping>
<servlet-name>ImageServlet</servlet-name>
<url-pattern>/image</url-pattern>
</servlet-mapping>