Thank you for the feedback, somehow I never got a notification on this, had to enable that manually in my profile.
The typical file in question is .csproj XML files. It's fine that it falls back to text merge, I'm just still not able to use an external diff/merge tool for the job.
I removed -lang=csharp option and that shows a different dialog when editing conflicts on .csproj files. If I shift+click text tool button, it still opens xmerge, but after closing xmerge I now get a new dialog saying an external merge tool was not configured. That's new and at least it tells me my configuration