Then I rather suspect, that something went wrong in the router setup:
You wrote:
"Site two: 10.0.0.0 subnet with 10.0.0.1 as the second server(not dns)"
What did you mean here ?

if you use nslookup instead of host to do the query, what is displayed about the server giving you the answer ?

10.0.0.1 is the server that I'm trying to setup in site two which needs to be able to resolve it's own name as backup.something.com from the DNS server at 10.0.2.1 in site 1.

When I do nslookup it says that the server giving the answer is 10.0.2.1 but it can't be as that doesn't have a record for my.router and it takes 0ms to reply. Where as if I do a lookup for 10.0.2.1 or something else it takes a few ms to reply. It just doesn't seem that the router is passing the request through the vpn

I'm totally lost

On the router, which is in the 10.0.0.0 network, you have setup the DNS to manual with 10.0.2.1 as the DNS server in the LAN/DHCP Setup page ?

Yeah. I've even tried resetting to factory defaults in case there was a config corruption. Haven't done that on the 10.0.2.0 network router yet though

The Draytek routers are able to proxy DNS requests more or less good, however, if you manually enter a DNS server of your choice, I thought it should work normal.
MacOSX however, there once was a problem when the DNS server you did specify in the network setup was asked after the DHCP server supplied servers, but this was fixed month ago.
Draytek had a bug, where the DNS server you specified in the UI was ignored, but that was also fixed long ago.
( to force the usage of the manually specified DNS server, telnet to the router and execute: srv dhcp forcednsmnl (or something like this, but I dont think the command is still availible)

I dont have many good ideas left, one thing maybe: what subnet mask do you use ? Draytek routers cannot service more then 254 clients, so, using a subnet which would match the 10.0.0.0/8 is not a good idea, better use 10.0.0.0/24.

Have you tried to use a Windows or linux based machine to check if this makes a difference ?

Each network is set up with 255.255.255.0 as the subnet mask.

I've just tested everything from windows xp and still same problem.

I just don't understand. As far as I can tell everything is correctly set up. The only thing I can think of that is left to do is to reset the router at site one to factory defaults and try again.

Can anyone out there confirm that the routers are capable of actually doing what I need? Has anyone out there been able to do it?