This definitely works, I have an example I have created. The CustomXslt tag in the .btm file looks like this when not using a custom Xslt file, just the extensions file:
<CustomXSLT XsltPath=”” ExtObjXmlPath=”.\extension.functions.xml” />
Typically I put the extensions file in the same project directory as the map and add it to the project. This is so it is maintained under source control