WinMerge compares by lines, and treats a block of lines that have differences as a single difference. You don't configure that, per se. That's not your problem.
Your problem is that Test2.txt doesn't finish with a carriage return.
So WinMerge compares This is a Test2\r\n
with This is a Test2<eof>
and these are different.
(And note how WinMerge treats the rest of the lines in Test1.txt as 'a single difference').
Confirmed with WinMerge 2.14.0.0