DNS Proxy is when the router responds to DNS requests from LAN clients that choose to ask it to resolve DNS. That choice is either manual by setting the LAN clients DNS servers to the LAN IP of the router, or DHCP on the router does this automatically.
DNS Service Forwarding removes the choice. When enabled, all DNS resolution requests from clients on the LAN of the router - no matter what public DNS server address they are trying to use, are forcibly sent to the DNS proxy on the router to be dealt with.
Unless the LAN clients are told (or chose) to use the DNS proxy on the router, enabling DNS Proxy will have no affect on DNS requests from those clients.
Yes, in that when DNS service forwarding is enabled all requests are forwarded to the embedded DNS proxy and the proxy will be default try and resolve DNS requests using the DNS servers listed in the WAN connection settings.
Look in the menu under the blue ‘?’ icon on the DNS Proxy bar and you’ll see two links - one for advanced DNS resolvers and the other for domain based dedicated lookup
When you click those you will see a section where you can add domain names and then specify which WAN’s DNS servers should be used eg for peplink.com only use WAN1 and USB WAN for DNS resolution:
You will also see a section where you can choose which WANs DNS servers should be used as forwarding DNS resolvers. By default its all WANs but you can limit it to specific WANS and you can choose to resolve all DNS queries over a PePVPN connection too if you want.
So a combination of these advanced settings using the DNS proxy and manually setting DNS servers on the DHCP servers of some VLANS and leaving others set to the internal proxy means that you have loads of control as to which LAN clients resolve their DNS queries where.