How VFP internally deals with this situation, where and how SQL is performed?
I'm talking about native VFP tables.

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As you are talking for native VFP tables, and as I suppose that O: stands for a shared network drive the answer is:
VFP will get whole the data to the client and the processing will be there - on the client machine. The VFP database is nothing than a MetaData about free-tables, so the shared VFP database is nothing than a network shared file.

In other words VFP is not a database server. So If you want processing to take part on the Server machine you may need to create DCOM components that will post you the data, or to upsize to a real database server.