Martin Burke, 59, of Lone Moor Gardens, and 56-year-old Patrick James Collett, of Rossnagalliagh, are both charged with possessing the weapon and ammunition with intent to endanger life, as well as in suspicious circumstances.
The pair appeared at Derry Magistrates’ Court for a first remand hearing.
It comes after the men were stopped by the PSNI’s Terrorism Investigation Unit in the Letterkenny Road area of the city last Tuesday evening.
During the hearing a PSNI detective said Mr Collett had been observed leaving Mr Burke’s home carrying a dark bag and placing it in the boot of his car.
The officer said the vehicle was stopped by police a short time later when the “fully functional and fully deployable” weapon was discovered.
Objecting to bail, a prosecution lawyer told the court that the “sinister aspect” of this case was that the weapon and ammunition found were compatible.
She also told the court inference could be drawn that the items were being moved on behalf of the New IRA.
A defence lawyer for Mr Collett said his client had felt pressured to move the items, telling the court Mr Collett could be described as a “patsy”.
He said there was no prospect of Mr Collett using the weapon, saying the accused had no involvement with any illegal organisations.
Mr Burke’s defence described him as a “chronic alcoholic” who spends his day in the pub.
The lawyer told the court Mr Burke’s family believe he is a vulnerable man who had been “exploited”.
Responding the bail application, the judge said too many questions remain over the case, which he acknowledged is at an early stage.
Bail was refused for both defendants who will appear in court again next month.
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